Stock Market Summary for February 11th 2008

Three-card Monte… A favorite game among con artists. Try and guess which card is the ‘money card’.

In our current banking and financial institution situation everybody is playing the "three-card monte" and the con artists are the companies who are trying to keep moving around the losses.

Today we learned that the auditors would not sign off on American International Group’s (AIG) financial statements. The auditors discovered "material weakness" in how it reported the value of certain credit default swaps. This all comes back to the issue we brought to our readers attention back in December. We said back then that auditors were likely to not sign off on the books if they saw anything questionable in how a company was coming up with values for certain assets. For our long time readers you will recall our many discussions on the "level 3" assets. Those assets for which a value can not be obtained by a mark-to-market or a mark-to-model system of asset valuation. Level 3 is known on Wall Street as mark-to-wild ass guess. Companies who have already suffered losses (or who don’t want to reveal losses) will place as much questionable assets into the category of level 3 assets and then calculate their value by using a system which does not tie in directly to any current market value. And this was going to lead to trouble later, and later has arrived.

When we discussed back in December the possibility that auditors were going to be digging through these assets very carefully it was because the entire independent auditing business got burned with Enron. When Enron imploded it took their auditors with them because the auditors were just as guilty as the company for moving assets around so that the losses would not show on the books. When Enron was found guilty of fraud and deceptive accounting, the auditing firm of Arthur Anderson was viewed as an accomplice and it destroyed that auditing firm which had been in business since 1913.

The current situation with collateralized debt obligations (CDO’s), structured investment vehicles (SIV’s), and other forms of ‘packaged loans’ which have been harder to unload than trying to sell sun tan lotion to an Eskimo are littering the books of many companies. And these companies are trying to find ways to place a value on them that will not reveal their true worth, or at least hide them until they are worth more. And the auditing firms are blowing the whistle and calling ‘foul’. In the case of AIG it would seem that this may have been the case. The auditors don’t like how the company was deriving value for some of their assets and now it appears that AIG will have to restate prior earnings. Whenever a company has to restate earnings it is bad news. We expect to see more companies in the future who will have their accounting firms blowing the whistle.

Today’s trading in the markets was lack luster. As Lisa stated in an earlier post the retail sector (RTH) has been seeing some interest as speculators are betting that all of the bad news is "baked in" the share prices. If your a gambler and like taking on high risk trades then I guess you can jump in with the other high risk players. But smart traders wait it out, wait to see if retail sales begin to flatten out and then start an upward trend. Those who are jumping into the financial and retail sectors are betting the worst is over. This is a bet we are not willing to take with our money yet. Some may look at a chart of the retail sector and say "the bottom is in.. time to jump in" for fear of letting some large gains slip by. Fear of missing that "big trade" is what has led to many investors ending up in the soup lines at the local homeless shelter. Betting on a bottom and waiting for a "confirmed" bottom are two different things. Waiting for signs of stability and a new up trend is the smart way to trade. Do you think that by waiting for better risk to reward profiles to present themselves to us will evaporate all of the gains to be had in the markets? Of course not, the stock markets have been around for a long time, there is lots of money to be made when the time is right. The smartest traders are like tigers, always stalking and waiting for their prey to be in just the right spot before striking. And it is those who wait and know when the time is right to strike that take home the prize to the family more times than the ones who chase everything that moves.

Talking heads are claiming that a bottom has been established in the markets now, wait a second… I have lost count of how many times I heard someone say "the bottom is in" since August of last year. We are still in a bear trend, and until we see a healthy bull trend redevelop we are waiting and stalking… We still feel that there are more lows to come.

A few months ago the US Government established the "hope now" effort to assist home owners with their mortgage if they were on the brink of foreclosure. Tomorrow we are going to get another Government program called "project lifeline". This one now goes another step in actually stopping foreclosure on a home until the banks can work out new terms. I don’t know how this can be accomplished without some rules being broken somewhere. Contracts and bank lending laws are all of a sudden going to be ignored?  Three months ago is was "hope now"… now things have deteriorated so much that we have gone from having "hope" to now needing a "lifeline" … sounds rather ominous to me. What is next… "project abandon ship" ?

Tomorrow morning I will post the retail sector chart and where that stands currently.