THIS WEEK’S ISSUE:
- In Play: Fannie Mae (FNM), Freddie Mac (FRE)
- In Play: Hurricane Ike
- Market Commentary: S&P 500, NASDAQ
- After Earnings Review: HRB, HOV, JOSB, BTH
- This Week’s Watch: Economic Reports & Notable Earnings Releases
IN PLAY: FANNIE MAE (FNM) / FREDDIE MAC (FRE)
UPDATE: The New York Stock Exchange (NYSE) announced that the common and related preferred stock of Fannie Mae and Freddie Mac will be halted news dissemination during the pre-market and available to all markets for trading at 9:30am (EST) on the morning of Monday, Sept. 8, 2008 due to U.S. federal regulators action related to Fannie Mae and Freddie Mac. After consultation with the FHFA, Treasury and the Securities and Exchange Commission, we feel that this decision will allow investors to digest the news that has been disseminated over the weekend, to interpret the news and the analysis that will be generated on Monday morning and to evaluate the resulting aggregate supply and demand. All markets will be free to trade both FNM and FRE as of 9:30am (EST), Monday, Sept. 8, 2008.
UPDATE: Standard & Poor's and Fitch Ratings on Sunday cut the ratings on preferred stock of troubled housing finance companies Fannie Mae and Freddie Mac to junk status after dividends were eliminated in a takeover by the U.S. government. The preferred stock ratings dropped to "C" from "BBB-minus," according to the S&P statement. It was the second cut by S&P in less than two weeks.
After-Hours Action: On Friday, September 5, FNM fell 21.9% to $5.50 and FRE fell 20.8% to $4.04.
Over the weekend, The U.S. Treasury announced a bailout plan for Fannie Mae (FNM) and Freddie Mac (FRE) that is supposed to meet three objectives: market stability, mortgage availability, and “taxpayer protection”. The conservatorship will not eliminate common stockholders (as of Sunday evening), and will place preferred holders second in case of complete loss. Common and preferred dividends have been eliminated, effectively immediately. The Treasury has also agreed to temporarily purchase GSE mortgage-backed securities. New investments by the Treasury will begin later this month. CEO Daniel Mudd of FNM and CEO Richard Syron of FRE have been replaced by Herb Allison (FNM), former vice chairman of Merrill Lynch and David Moffett (FRE), former vice chairman of US Bancorp.
Under the plan, the Treasury will purchase $5 billion of mortgage-backed securities for both FNM and FRE. In addition, the Treasury will receive $1 billion in new senior preferred stock with a 10% coupon from both firms as “compensation” for providing support. The Treasury will also receive warrants representing 79.9% ownership in both firms. The Treasury does not expect to exercise the warrants since the exercise cost is less than $1 per share. For both firms, if liabilities exceed assets on their balance sheets, the Treasury will inject new capital following each earnings report and the first round could be as soon as within 60 days of the September 30th report.
Here’s my take (and the views of many others) on the situation: If the warrants are exercised at the full 79.9%, then the value of the common stock for both firms could be wiped out. Since the preferred holders come in second under this plan, they’ll take a massive hit if loses continue their momentum, not to mention the elimination of dividends (which could make them nearly worthless now). The message that the government is sending is that even though they announced that they won’t bailout additional firms after Bear Sterns, they just bailed out not one, but two, at the same time. This leads you to believe that although the Treasury is taking steps to building confidence in the market, investors should be aware that all public statements made by government officials are prepared and designed to exhibit confidence, regardless of how bad the news really is.
The largest shareholders of FNM and FRE. Mutual fund Dodge & Cox owns approximately 69.4 million shares in FNM and Legg Mason Capital Management owns 79 million shares in FRE. In addition, the top 5 major holders in both firms total well over 200 million shares. FNM currently has 1.07 billion shares outstanding. FRE currently has 647 million shares outstanding.
In addition, numerous broker-dealers, have taken large positions in preferred stock. JP Morgan recently reported that its $1.2 billion investment in FNM and FRE preferred shares lost 50% of its value now at $600 million. Hedge funds, such as William Ackman’s Pershing Square Capital Management, has greatly benefited from shorting shares earlier this year. I have a copy of Mr. Ackman’s July 2008 plan to “Save Fannie and Freddie” in PowerPoint and will be happy to distribute if e-mailed: JCLee84@hotmail.com.
In Asian trading, at the time of this writing, the Nikkei 225 jumped 3.4%. The Korean Kospi jumped 5.4%. Hong Kong’s Hang Seng jumped 4%. Singapore’s Straits Times jumped 3.9%. Australia’s ASX 200 jumped 3.9%. Taiwan’s Stock Market is up 5.6%. All mainland Chinese indices were down. Currently, all European indices are up 2-4% on the news. The consensus is that the world has agreed positively with the Treasury’s plan for a bailout.
U.S. futures (at the time of writing) are up 2-2.5%. The Dow futures are up 227 points, up 2.02%, the S&P 500 futures are up 31 points, up 2.5%, and the NASDAQ futures are up 34.25, up 1.94%.
I expect massive selling on the morning hours for both stocks from institutions, forced liquidation/margin calls from long hedge funds, and retail selling all across the board. There is a distinct possibility that FNM and FRE could be halted during trading hours due to the possible inability for the NYSE specialist to balance the large number of orders at the open since pre-market trading has been halted by the NYSE. Expect considerable volatility throughout the day for both FNM and FRE. If shares fall below $1, especially for FRE, the NYSE will most likely halt the stock. However, that also runs the risk of the Treasury exercising its warrants. Long or short positions should not be placed until the “dust” clears and the Treasury releases more details on the new plan.
I expect the major indices to hold their gains for the short-term due to the fact that most of the uncertainty surrounding both FNM and FRE has been solved and traders see the sign as news that the housing recovery may soon be in place. The reality is that the housing recovery will not come quickly and I expect the recovery to remain at a very slow place and to continue into all of 2009 as excess supply remains yet to be neutralized. If a sell-off does occur in the major indices and forms a bearish gap up, then the rally is effectively over.
Pay attention to more news that is expected to be released during pre-market hours.
IN PLAY: HURRICANE IKE
Hurricane Ike is projected to hit the Gulf of Mexico on Wednesday, currently with sustained winds of 120 mph. NYMEX crude oil is currently up nearly $2 to $108.20, at the time of this writing. Expect volatile trading in oil and natural gas for the entire week.
Keep an eye on this one: http://www.nhc.noaa.gov/
MARKET COMMENTARY -- INDU 11,628.06, COMP 2,414.71, SPX 1,292.20, RUT 737.60
My outlook on this week’s market is entirely unknown and even though a breakdown occurred due to the negative employment situation (unemployment rose to 6.1%), the future outlook is uncertain. Therefore, I have no opinion whatsoever. The breakdown can be easily negated if buying momentum is sustained throughout the day today. As mentioned, a bearish gap up, with a large intra-day sell off, will be considered a continuation of a new primary downtrend. Otherwise, the rally will still be intact, regardless of the previous employment situation report.
I won’t be profiling the DJIA this time since the chart is very similar to the S&P 500. As you can see, the rally in both indices have broken down, more so with the NASDAQ. The volume trend remains the same where the volume on down days still exceeds the volume on up days. Make no mistake; we are still in a bear market, regardless of the potential 3-4% move today.
This is the first (of many) times where I will state no opinion on the likelihood of a week’s market outlook. No one will know what will happen at this point but today will set the tone for the rest of the week and will either confirm a downtrend or confirm a one-day reversal back to the upside, keeping the rally intact. There’s no sense or point in trying to predict the direction for this week.
AFTER EARNINGS REVIEW: HRB, HOV, JOSB, BTH
For complete analysis on the profiled companies, please visit: http://www.seekingalpha.com/author/john-c-lee.
H&R Block (HRB) – On Wednesday, September 3 after-hours, H&R Block Inc. (HRB) reported a Q1 ‘09 loss of $0.41 per share or $132.7 million on $339.6 million in revenue vs. a loss of $0.93 per share or $302.6 million on $381.2 million in revenue a year ago. Analysts expected a loss of $0.35 per share on $378.3 - $381.2 million in revenue, missing both earnings estimates and revenue targets. Tax Services increased 7.7% to $75.3 million vs. $69.9 million a year ago. Shares were down about 3.5% after-hours and the previous session’s close marked the highest that HRB’s stock traded at since November 23, 2005 when it hit $26.66.
Technically, HRB broke out and has drifted up ever since. I expect some consolidation in this area. Support is at $24.10.
Hovnanian Enterprises (HOV) – On Wednesday, September 3 after-hours, Hovnanian Enterprises (HOV) reported a Q3 ’08 loss of $2.67 per share or $202.5 million on $716.5 million in revenue vs. a loss of $1.27 per share or $80.5 million on $1.1 billion in revenue a year ago. Excluding pre-tax land charges of $11.7 million, the loss would amount to $87.7 million. Analysts were expecting a loss of $1.57 per share on $703 million in revenue. Shares were down $0.65 or 8.4% to $7.10 in after-hours trading and should gap down today.
Technically, shares have declined ever since HOV hit its high on 7/20/2005 at $73.40. Shares now sit at 2002 levels when the housing market began to pick up. For the long-term, HOV is a buy for investors who wish to hold for at least two years. HOV appears to have stabilized and is forming a multi-month/year rounded-out bottom. For the short and intermediate-term, HOV will most likely trade in a neutral-range for many months to come.
Jos. A. Bank (JOSB) – On Wednesday, September 3 intra-day, Jos. A Bank Clothiers (JOSB) reported Q2 earnings of $0.48 per share or $89 million on $152.7 million in revenue vs. $0.44 per share or $8.2 million on $134.3 million in revenue a year ago. Analysts were expecting $0.45 - $0.46 per share on $147.4 million in revenue, beating both earnings and revenue estimates. Share broke out at 2PM, up $2.93 or 11%, to close at $28.69 on 2.2 million shares.
Technically, JOSB has been trading in a neutral-bound range of $20-$31 for 10 months. JOSB is making higher lows, bullish. In addition, the breakout intra-day when earnings were announced penetrated the $29 resistance level and is continuing to head higher. The next level of resistance within one-year is at $31.50. JOSB should have no problem reaching that level in the short-term.
Disclosure: The author holds a short-term long position in JOSB.
Blyth (BTH) –On Thursday, September 4 pre-market, Blyth Inc. (BTH) reported Q2 earnings of $0.08 per share or $3 million on $236.8 million in revenue vs. earnings of $0.08 per share or $3.2 million on $234.9 million in revenue a year ago. Excluding items, BTH earned $0.09 per share vs. $0.16 per share a year ago. Analysts were expecting $0.15 per share before items, on $236.7 million in revenue, widely missing expectations. Shares gapped down opening at $13.74, declined sharply, but recovered during the day to close at $12.07, down $3.81 or 24%, on 937,000 shares traded (3x the average daily volume).
Technically, BTH formed an ascending triangle following the 25-day MA, which is usually bullish, however, BTH formed a breakaway gap and is testing support at $11.80. BTH also cut through the 50-day MA and will act as resistance if a dead cat bounce occurs. Risk/reward does not favor either long or short positions at this time. Shorts should look for a weak pullback and longs should wait until BTH shows signs of bottoming out and higher lows.
THIS WEEK’S WATCH:
- FNM and FRE, the entire financial sector
- Hurricane Ike, Crude Oil, Natural Gas, Exploration/Drilling/Refining industries
Economic Reports: Mon. (Consumer Credit - 3PM), Tues. (Pending Home Sales – 10AM, IBD/TIPP Economic Optimism, ICSC-UBS Weekly Retail Sales – 7:45AM, Wholesale Trade – 10AM), Wed. (Weekly MBA Mortgage Applications – 7AM, Weekly EIA Energy Inventory – 10:35AM), Thurs. (Trade Balance – 8:30AM, Import & Export Price Index – 8:30AM, Initial Jobless Claims – 9AM, Treasury Budget – 2AM), Fri. (PPI – 8:30AM, Advanced Retail Sales – 8:30AM, University of Michigan Consumer Confidence – 10AM, Business Inventories – 10AM).
Noteworthy Expected Earnings: Mon. (none), Tues. (PBY - B, JWA – D/2:30PM, KFY - D, PAY – D/1:30PM, SHFL - A, OXM - A, AVAV - A), Wed. (STEI – D/10:00AM), Thurs. (CPB - D, KKD - A, PNY – D/2:30PM), Fri. (none).
Key: B – Before Market Open, D – During/Intra-day, A- After-hours.
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