Monday, September 15, 2008


  • In Play: Lehman Brothers (LEH)
  • In Play: Bank of America & Merrill Lynch
  • In Play: American International Group (AIG), Washington Mutual (WM), UBS AG (UBS)
  • Market Commentary: DJIA, S&P 500, NASDAQ, CBOE VIX
  • 5 NYSE & 5 NASDAQ Stocks Making 52-Week Highs
  • This Week’s Watch: Economic Reports & Notable Earnings Releases

U.S. FUTURES (as of 5:30AM EST): DJIA -312, NASDAQ -48.25, S&P 500 -41.90

IN PLAY: Lehman Brothers (LEH)

What a sad, sad story. There are numerous questions that shareholders, employees, and others are asking right now. All I have to say is that IT WAS COMING. That’s it. There’s no excuse for shareholders. Why do people think that the worst of the crisis is over? It’s not! Things like this get worse before they get better, and we have a lot more troubled firms to deal with in the future (For example: AIG and WM, to name a few). Unfortunately, the Treasury/Fed lending well has dried up, so don’t expect the same $30 billion in Fed-backed loans to save other firms. And that’s exactly what happened tonight.

Lehman filed for Chapter 11 bankruptcy. This is the largest bankruptcy filing in history ($613 billion in debt) The bankruptcy will not include broker-dealer operations and the Neuberger Berman unit, and other units. Lehman was founded in 1850 by the Lehman brothers, Henry, Mayer, and Emanuel, first as a cotton-trading operation in Alabama, moving its way up to provide a wide range of financial services. LEH has a rich history of mergers and acquisitions including with American Express, Abraham & Co. Trading, Kuhn, Loeb & Co., and Shearson, finally becoming independent in 1993 under CEO Harvey Golub.

They survived every major financial crisis, including the Great Depression, until now. CEO Richard Fuld took over since Mr. Golub.

I just have to say that this was Fuld’s fault. John Gapper said it best: “Fuld never changed, not really. He was still the same dark, obstinate Lehman loyalist that he had always been - a man who never wanted his firm to be sold. And, in the end, Mr Fuld's pride and obstinacy stood in the way of Lehman's desperate efforts in the past half year to right itself...He had devoted so much of his life and his personality into moulding the bank he could not accept its decline. If he had sold out earlier, Lehman might have survived but he was too proud. It was hubris, followed by nemesis.

Hubris (American Heritage) – Overbearing pride or presumption; arrogance, excessive pride. I would specifically add, “inability to admit fault”, “general widespread dishonesty”, and “misleading the public on TV”, among anything else you as the reader wants to add. And don’t even tell me that a CEO doesn’t have any knowledge of what’s going on. The next CEO that says that (i.e. Alan Schwartz – Bear Sterns) will have a tough time covering his assets in the future.

Remember when Fuld commissioned former CFO Erin Callan to act as head cheerleader for LEH earlier this year? At the same time, LEH executives condemned short seller David Einhorn (of Greenlight Capital) for shorting Lehman and calling his accusations false. In my experience, high-profile short sellers have sufficient evidence to back up their position and I consider short sellers, as a whole, to be the best analysts in the world because they’re not biased to the long side nor do they have any interest in any firm (not being employees of a publicly traded company). They are the masters of finding deception, mistakes and irregularities. At this point, any executive of any financial firm that comes out on TV saying anything should be hear with skepticism and any short sellers that come out should be hear with an open mind. Shorts were right this entire year, and financial executives have lost every time. Notice the trend?

Here’s a timeline of Lehman’s history since the start of the credit crisis 13 months ago (Courtesy of CNBC):

-Aug. 22, 2007: Announces plans to shutter its subprime mortgage business, eliminating 1,200 jobs.
- Sept. 20: Chief Financial Officer Chris O'Meara steps down to head global risk management division. Erin Callan, head of the investment banking practice for hedge funds, succeeds him.
-Dec. 13: Reports fiscal fourth-quarter profit of $870 million and full-year earnings of $4.2 billion.
Jan. 17, 2008: Lehman says it will stop originating mortgages through wholesale channels amid continued weakness in the housing and real estate markets.
-March 16: The federal government and JPMorgan Chase & Co. bail out Bear Stearns Cos. Analysts question whether other investment banks might also collapse.
-March 17: Reports suggest Southeast Asian bank DBS Group Holdings Ltd. instructed its traders to cease working with Lehman, though those instructions were later rescinded.
-March 18: Announces it earned $489 million during its fiscal first quarter.
-April 1: Raises $4 billion in capital.
-April 15: Speaking at the investment bank's annual shareholder meeting, Chairman and Chief Executive Richard Fuld tells investors that the worst of the credit crisis is behind Wall Street, but that the environment "will remain challenging.
-May 16: Announces it is cutting 1,400 jobs, or about 5 percent of its work force.
-June 9: Estimates it lost about $3 billion for the second quarter and that it is raising $6 billion in fresh capital.
-June 12: Removes Callan as CFO and Joseph Gregory as chief operating officer. Herbert McDade replaces Gregory, while Ian Lowitt replaces Callan.
-Aug. 29: The New York Times reports Lehman is preparing to cut 1,500 jobs.
-Sept. 2: Reports indicate state-owned Korea Development Bank was considering buying a 25 percent stake in Lehman.
-Sept. 8-9: Shares of Lehman plunge 52 percent amid worries the investment bank was struggling to find new investors and raise capital. Reports say the talks with KDB have ended.
-Sept. 10: Lehman says it lost $3.9 billion during its fiscal third quarter and plans a number of moves to shore up its balance sheet. The announcement, coming a day after Lehman shares lost 45 percent, is an attempt to assuage market worries. Fuld says the firm will consider all "strategic alternatives."
-Sept. 11: Lehman shares skid another 42 percent as investors reject the plan, forcing Lehman executives to scour Wall Street for a financial lifeline.
-Sept. 12: Late Friday night Wall Street executives and top
U.S. financial officials convene at the New York Fed to discuss how resolve Lehman's situation before it shakes investor confidence in the U.S. banking system.
-Sept. 13: The group reconvenes at the New York Fed as foreign finance ministers urge a solution before Asian markets open.

Lehman up to this point holds approximately $60 billion worth of toxic real estate-related holdings, unable to get them off its books or find a hero to save the firm. There were many indications of warning like most impending disasters. The failure of getting support from Asian firms/banks, such as the Korea Development Bank, and the withdraw of interest from several other firms suggested that Lehman’s books were kept in private to hide the true nature of the beast, especially if Bank of America and Barclays pulled out along with other major Wall Street firms. The continued decline in LEH’s share price also suggested that something else was going on behind the scenes at LEH, all the while trying to sooth investors from their worries. The market is never wrong.

This is mostly unfortunate for Lehman employees who own approximated 25% of the firm. They were guided by a wolf in sheep’s clothing and unfortunately, nothing can be done with restricted shares. This is the same story happening over again. Any bank employees thinking about purchasing more shares in their own company, at the company’s request, should learn a lesson from this trend.

I believe it was the right decision to let LEH fail. I also praised the Federal Reserve and the Treasury for keeping to their word by not providing capital to the firm or any other firm in the future. So far this entire year, the Treasury and the Fed have done certain things that were contradictory to their statements, but now they have stood firm. This is a lesson of hubris, the pride and the greed that, once hedonistically savored, will be difficult to get out of. Other firms make note: there is no Fed/Treasury-backed bailout for you.

What about the shares for this morning? Expect what you think would happen to a publicly-traded company that just filing for bankruptcy. Shares will get cratered more so than FNM and FRE, obviously. The stock will get delisted very soon and I wouldn’t be surprised if shares get halted today. Longs beware!

There’s more news on Lehman, but I think that by now you’re reading the headlines yourself.

IN PLAY: Bank of America (BAC) & Merrill Lynch (MER)

By now, you’ve heard that Bank of America (BAC) has agreed to buy Merrill Lynch (MER) for approximately $50 billion (or $29 per share). If you haven’t noticed, MER shares are trading at $17.05, and the offer price is at a 71% premium. The deal includes $4 billion in MER common stock as well as $6 billion in options, convertible shares, and restricted shares. Many people say that it’s a crazy price and it’s too expensive while analysts say that the fair value is $40 per share. It doesn’t matter what people think, the market will make that decision for you.

The sale includes MER’s stake in Blackrock, which has $1.4 trillion in assets under management (AUM). BAC current has $589 billion in AUM. Together with the Countrywide acquisition, I believe that Bank of America will be the next super financial conglomerate after Citigroup. You’ll notice another trend where broker dealers are failing and commercial banks are not. This is due to the fact that banks such as BAC have the cushion of billions in customer deposits to fall on. No major commercial bank has failed thus far. So, for future reference, keep an eye on the broker dealers without commercial major commercial operations. This deal has been approved by both boards but is subject to approval by regulators (not hard given that the Fed had a hand in this) and a vote by shareholders of BAC and MER.

My real opinion? This is a mistake. Why buy MER for $29, when the firm could have been gotten cheaper? Answer: The Fed is trying to prevent another Lehman. It’s all about liquidity and confidence – the two most important words in this market.

What will most likely happen is that BAC will gap down lower and MER will form a breakaway gap near $29. That’s how these things work. MER shorts, be aware that it’s unlikely that MER shares will ever touch $17 again unless BAC somehow backs out of the deal or shareholders don’t approve (which is highly unlikely given that the Fed has forced the deal to happen, according to numerous sources). The Fed always seems to make things happen.

IN PLAY: American International Group (AIG), Washington Mutual (WM) & UBS AG (UBS)

Another troubled financial firm is American International Group (AIG). AIG’s market cap is $32.64 billion and they just announced a plan to raise $40-$50 billion in liquidity! What does that tell you? They’re in some serious liquidity trouble. The firm is currently in talks with the Fed (for short-term financing), Warren Buffett, the NY Insurance Department, and private equity firms. AIG is also looking to avoid an imminent downgrade from the major ratings agencies. Whatever they’re talking about better be quick. Did you know that AIG was founded in China 89 years ago? Me neither.

Washington Mutual (WM) is another struggling firm that is highly likely to be taken over. There were reports that JP Morgan (JPM) was in talks with WM, but the reports were false. WM also announced that they were “well-capitalized” but why have shares fallen 30% last week and over 90% so far in the past 12 months not trading a $2.73? The market is never wrong. Both Fitch and Moody’s downgraded WM’s debt rating on Thursday. In addition, WM got the courage to replace the CEO recently so they’re on the right track. But how long do they have to survive? Loan loss provisions are now estimated at $4.5 billion for Q3 and they are scheduled to report earnings on October 22.

UBS AG (UBS) announced over the weekend that they’re taking an additional $5 billion in write-downs. This is in addition to the $42 billion they wrote down since the credit crisis started. This leaves the same question: How long do they have to survive?

There seems to be a lot of press on the major firms. But what about the smaller, regional banks? So far, there are 313 lenders and banks that have failed (to my knowledge). More to come!

MARKET COMMENTARY -- INDU 11,421.99, COMP 2,261.27, SPX 1,251.70, VIX 25.66

I don’t know what to say honestly; except that this is the most manipulated market I have ever traded in since I started six years ago. It’s unbelievable. My currently policy as of last Friday is to cut all positions by half and go into cash. It’s the safest action and there’s nothing wrong with holding cash and waiting for the right opportunity. It’s a blessing that I don’t hold LEH, MER, BAC, AIG, WM, UBS (or all the firms mentioned above) for one simple reason: no one knows what will happen on the weekends. Since there is a lot of activity on the weekends, I refuse to take the risk and any prudent trader would do the same. I advise all traders to take defensive measures and act conservatively in anticipation of additional market-moving news this week, and of course prepare for anything that may occur on the September 20-21 weekend. By now, you’ll have noticed the weekend trend.

The DJIA and S&P 500 are forming similar patterns, but decided to post both to note a difference. The DJIA has yet to test the July low where as the S&P 500 has tested closet to the low. Notice the massive increase in volume that was not present in the past three weeks (refer to my last three newsletters, available for download (PDF) for free on The negative that I see is the consolidation may be wide-ranged flag patterns that may signal a continuation to the down side. If you checked the futures, the market will gap down and the indices will test the July low. Whatever happens today, will determine whether we start a new primary leg down or if we hold the lows and trade in a neutral range.

As for the NASDAQ, the index has already tested its low successful for now. The only negative is that the volume is again declining on the most recently up days. On a major reversal day, I need to see huge volume, preceding the volume level of previous days in order for me to confirm buying conviction, otherwise, the September low will not hold. Given the futures action this morning, it looks like the NASDAQ will once again test the low.

I profiled the VIX today because the sentiment indicator could not be more effective on days like today. I expect a bearish gap up close to the 30 level and a fade throughout the day. This is an indicator that measures fear, and what better day to watch it than today?


Alpharma Inc. (ALO)

  • Drug manufacturer for humans and animals.
  • King Pharmaceuticals (KG) started a $1.6 billion tender offer on September 11 for $37 per share. This is up from KG’s $1.4 billion offer in August.
  • ALO condemns the hostile takeover attempt and took on a shareholder rights plan which should make it more difficult for KG.
  • Jefferies & Co. downgraded ALO from “Buy” to “Hold” on September 12.
  • ALO formed its second continuation gap indicating that the stock is heading higher.

Covidien Ltd. (COV)

  • A healthcare company specializing in devices, drugs, imaging, and supplies.
  • COV reported positive earnings this entire year and beat estimates in their latest four quarters (Q308 reported: $0.72, estimate: $0.66. Q208 reported: $0.66, estimate: $0.59, Q108 reported $0.59, estimate: $0.57, Q407 reported: $0.63, estimate: $0.60).
  • BMO Capital Markets upgraded COV from “Market Perform” to “Outperform” on September 11.
  • COV continues its uptrend having broken through $55.50 resistance (prior high). Major moving averages continue to slope upward.

Nicor Inc. (GAS)

  • A natural gas distributor that also owns one of the largest cargo carriers in the Caribbean as well as provides service contracting for repairs and maintenance for everything related to natural gas.
  • GAS reported positive earnings this entire year and beat estimates in their latest three quarters (Q208 reported: $0.59, estimate: $0.28, Q108 reported: $0.91, estimate: $0.89, Q407 reported: $1.2, estimate: $1.11).
  • GAS is outperforming most of its competitors and has remaining resilient ever since the sharp decline in natural gas prices.
  • Formed a long-term reverse head-and-shoulder pattern (not shown) which broke out mid-August. Uptrend remains intact and recently broke through $47 resistance (prior high). Major moving averages continue to slope upward.

Ikon Office Solutions Inc (IKN)

  • Involved in the copier and printer business, provides professional services such as technical support and strategy assessments and provides lease financing to customers.
  • Ricoh announced in August that they will acquire IKN for $1.62 billion or $17.25 per share in cash. Unlike ALO, this deal has been approved by both companies.
  • IKN reported positive earnings this entire year and beat estimates for the latest two quarters (Q308 reported: $0.37, estimate: $0.35, Q208 reported $0.24, estimate: $0.23, remained in-line for the past three quarters thereafter)
  • Outperforming its two closest competitors, Pitney Bowes Inc. (PBI) and Xerox Corp. (XRX) by a wide margin.
  • On the day of the deal announcement, IKN formed its third continuation gap. Currently in consolidation and about to breakout.

Leggett & Platt Inc. (LEG)

  • A consumer discretionary company focusing on home furnishings. The entire sector has been performing well along with the consumer staples sector.
  • LEG hasn’t performed too well with earnings, coming in-line in Q208 ($0.28) and missing in Q108 (reported: $0.23, estimate: $0.25).
  • The August 25 upgrade by Stifel Nicolaus (“Hold” to “Buy”) helped fuel the uptrend from its high-and-tight flag consolidation in August.
  • The uptrend remains intact, but I expect a pullback to the mean.


Gibraltar Industries Inc. (ROCK)

· A component of the steel & iron industries. Unlike many if its peers, ROCK has been going up instead of getting crushed. ROCK’s stock performance is the complete inverse of companies such as Rio Tinto (RTP), Arcelor Mittal (MT), POSCO (PKX), and Tenaris (TS).

· On August 8, ROCK reported Q2 earnings of $0.67 per share vs. $0.40 per share a year ago. Analysts were expecting $0.38 per share, crushing estimates. ROCK also surprised in Q1, reporting earnings of $0.27 while estimates were at $0.14 per share, a nearly 100% surprise. Turns out that ROCK made significant improvements in their cost structure. They also raised guidance for the full fiscal 2008 year.

· ROCK was upgraded by Robert W. Baird to “Outperform” and RBC Capital Markets raised their price target to $21 from $15.

· ROCK made two continuation gaps, both from exceptional earnings. The trend is highly likely to continue higher, divergent from the steel & iron sector’s performance.

Questcor Pharmaceuticals Inc. (QCOR)

  • This company has only two products, but they command the market for childhood neurological disorders. Although the diseases are rare, QCOR’s products extremely effective are the first in line for treatment.
  • QCOR has also been reporting positive earnings for the past six quarters.
  • In addition, QCOR has been repurchasing shares all year, with a total of 2.7 million common shares valued at $11.8 million and all of its outstanding A-series preferred shares for $10.3 million. On September 4, QCOR repurchased 1.8 million shares at $5.06 per share from Iverlochy Consultadoria & Servicos L.D.A. They won’t be stopping here though; QCOR has an additional 3.5 million shares able to be repurchased under its program.
  • On September 11, Stanford Research and Soleil initiated coverage, both issuing “Buy” ratings.
  • As of August, 13.4% of shares (float) were short. I suspect that the number has sharply declined.
  • QCOR spiked out of its multi-month consolidation, having broken through numerous support levels, aided by substantial short-covering. I expect a pullback as soon as buying momentum subsides.

Northern Trust Corp. (NTRS)

  • This bank is amazing. What’s amazing is that NTRS reported positive earnings every quarter since 2005. That’s every single quarter since the start of the housing and credit meltdown.
  • Nonperforming assets as a percentage of total loans are at 0.12%, much lower than many banks that took the hit. This bank is about quality, and if someone really has to buy a bank, then NTRS is it.
  • The short interest is only 2.4%, so don’t expect a lot of pressure from shorts (unless they’re crazy). This is the definitely the wrong bank to be shorting.
  • NTRS’s uptrend remains intact and doesn’t look it will give up. This whole crisis is NTRS’s big opportunity to take advantage of the failure of dozens of regional banks.

Medicines Co. (MDCO)

  • A pharmaceutical company focusing on acute care.
  • MDCO beat estimates for every 2008 quarter so far (Q208 reported: $0.8, estimate: $0.07, Q108 reported: $0.09, estimate: $0.05).
  • MDCO announced in August that they will acquire Curacyte Discovery GmbH, a German-based critical case medical company.
  • Cleviprex, a drug recently approved by the FDA for high blood pressure, is expected to be a $200 million/per year drug.
  • MDCO saw a recent spike. The uptrend continues and I expect MDCO to continue to hit new 52-week highs.

Hawaiian Airlines Inc. (HA)

  • Despite missing estimates for the past two quarters (Q108 being a loss of $0.42 per share), HA keeps on flying to new highs. This is one of the very, very few airlines that are actually up YTD. It’s actually up approximately 120% so far YTD.
  • HA is doing so well because it’s main competitors, Aloha Air and ATA airlines, have both shutdown since the first week of Q2.
  • As oil prices subside, I expect HA to perform even better than they did when oil was at $145.
  • The uptrend is intact without any major breaks. Both the 50-day and 200-day MA’s continue to slope upward.


  • U.S. Dollar, Crude Oil, Treasuries
  • Economic Reports and Earnings Reports listed below.

Economic Reports: Mon. (Empire Manufacturing – 8:30AM, Industrial Production – 9:15AM), Tues. (CPI8:30AM, Net Long-term TIC Flows – 9:00AM, NAHB Housing Market Index – 1:00AM, FOMC Rate Decision – 2:15PM, Weekly Retail Sales – 7:45AM), Wed. (Weekly MBA Mortgage Applications – 7:00AM, Current Account Deficit – 8:30AM, Housing Starts – 8:30AM, EIA Petroleum Report – 10:35AM), Thurs. (Initial Jobless Claims - 8:30AM, Philadelphia Fed – 10:00AM, Leading Indicators – 10:00AM, Money Supply – 4:30PM), Fri. (Watch for Quadruple Witching!)

Noteworthy Expected Earnings: Mon. (KG - D, TITN - B), Tues. (BBY - D, CBRL - D, DRI - A, GS - B, ADBE - D), Wed. (DBRN - A, GIS - B, MS, MLHR - A), Thurs. (CCL - D, CTAS - A, CAG - B, FDX - B, LEH, ORCL - A, PALM - A, PIR - B), Fri. (None Noteworthy)

Key: B – Before Market Open, D – During/Intraday, A- After-hours.



glin said...

the era of easy credit comes to an end. greenspan, besides fuld, will be damned by history.

John C. Lee said...