Weyerhaeuser's Reaction Indicates the End of the Rally Is Near

Yesterday, Weyerhaeuser Co (WY) reported earnings of -$1.25/share. The market was expecting -$.80/share. This is a miss of more than 50%. Plus, WY said that next quarter's loss is expected to be as large as this quarter's loss (if not larger). This guidance would not be termed good. The earnings estimate for next quarter was -$.59 before this quarter's announcement. Guiding approx. -$.65/share lower cannot be termed good. Losing $264M in one quarter cannot be termed good. Yet on this news, the stock quickly rose to a high of $37.46 soon after the open yesterday morning. That's about a dollar or more above the close Monday. When stocks start going up on news like this, the market is exhibiting unreasonable exuberance. This kind of unreasonable exuberance usually marks market tops. The Lumber futures are down very slightly on the day, so that is not it. Admittedly, the pending home sales data and construction data yesterday were better than expected, but that type of news normally only results in a one day move upward. If that were the cause, one might logically expect the lumber futures to be up also.

Some people are speculating that the stress test results release has been delayed to ensure that the Japanese are able to fully engage when the results are released. Thursday will be the first day this week that the Japanese markets will be open. The running theory is that the stress test results are supposed to make the banks look good. This might cause the market to buy the bank stocks. If the WY result behavior is any indication, that might just be the last spurt of the buying spree.

Earnings season is largely over after this week. The expectations were set very low, so many companies have looked good relative to the expectations. Even those that didn't beat expectations, such as WY, have still often gone up. However, once the main weeks of earnings are over, the market will not have that constant spur to drive it upward. Reality is more likely to set in. Irrational exuberance simply cannot go on forever. Plus the rapidly deteriorating commercial real estate market and the rapidly deteriorating credit card markets are likely to soon take their toll on bank stocks. Perhaps the banks will have time to raise their capital before their stocks crash again. Perhaps the fact that many of the 19 are being asked to raise more capital will cause the banking stocks to crash (on dilution concerns and stability concerns). One thing is sure, the type of buying exuberance shown by WY today is not likely to continue for long. There is a good chance this behavior is marking the near term top of this rally.

Consider also the huge rally in the banking stocks yesterday. The commercial real estate market is supposed to be souring dramatically this year and next. The residential real estate market is still going down. Many loans are souring in that area also. Plus as the unemployment rate grows, the banks' credit card businesses are predicted to have serious problems. Those businesses were barely profitable last quarter. COF's charge off rate for the quarter was 8.4%. However, COF's charge off rate for March was 9.3% (substantially above the unemployment rate). The unemployment rate is predicted to be reported as 8.9% - 9% at the end of this week. Generally the charge off rate roughly follows the unemployment rate. COF cited reasons in its quarter statement that its charge off rate might exceed the unemployment rate. This likely means the credit card businesses will not be profitable for the rest of this year and at least a good part of next year. Banks such as COF, BAC, C, WFC, etc. with huge stakes in each of these areas are likely to show good sized losses in the near future. These banks may end up being much more stressed than the stress tests have evaluated for.

Even the lawmakers (Congress) have said they think the stress tests are too close to the current conditions to be valid safeguards. When WFC, COF, and BAC can shoot up over 15% in one day (Monday) under these conditions, one might again think that the market is being overly exuberant. Even under the "lightly stressful conditions", reportedly 10 or more of the 19 banks are being asked to raise more capital. The banking problems are not going to mystically disappear because of satisfaction with a rather mild stress test result. The banks are not going to be completely stabilized by a modicum of extra capital due to government demands after a mild stress test. One could argue there may be reason for cautious optimism. Unreasonable exuberance is just that, unreasonable.

This rally has had very little consolidation in it. It has risen straight up from a bottom. When it finally begins to retreat, it may go down just as quickly. The over exuberance we are currently seeing often marks the top of rallies. At the very least a prudent investor should be very cautious at this time. It is not the time to be chasing a trade.

Comments

[sbenard:]

I saw some interesting data last week from John Mauldin that indicated that 2009 will show a respite from residential mortgage resets. However, the same data showed that in 2010, residential mortgage resets will begin again in earnest, peaking in 2011 at even higher levels than during 2007 and 2008! Thus suggests that more pain is yet to come.

May 06 06:17 AM

[friar tuck:]

hey benard , you just gave yourself away as a short seller. eveybody plays with pain, if you can't, then sit the bench. put your money in a savings account and watch the caboose pull away. almost every stock out there is not only in pain they are are downright injured. getting released from the hospital is the first step of recovery. and that's all that has occured so far. it was unreasonable fear(GE AT 7.00???) that caused this crash and there's nothing wrong with a little unreasonable exuberence to balance everything out. do you think WY is just going to roll over dead?

May 06 09:32 AM

[David White:]

I know I wrote about an expected surge in banking stocks on Thursday due to the stress test news. However, with today's upward movement, there has already been a 25% or more movement upward in many banking stocks this week. It could turn out that this will be another of those "buy on rumor, sell on news" cases. Hold onto your hats!! It's anybody's guess what will happen tomorrow. I have put a few statistics below. They list the prices at Friday's close and an price after 2pm ET today (5/6/09).

Bank Friday's Close Price Now % Gain
WFC $19.61 $25.84 31.8%
BAC $8.70 $12.61 44.9%
COF $17.34 $22.95 32.4%

May 06 02:10 PM

[User 408744:]

Weyerhaeuser mentioned the black liquor tax credit in their earnings call. Look and see what it did for IP.

May 06 04:50 PM

[Mad Hedge F...:]

It may be time to take a trading profit. With the lumber industry approaching its fifth year of what is nothing less than the Great Depression II, you’d think that this is the last place that futures traders would want to play. Prices for this commodity are driven primarily by housing starts, which have been in a death since 2006. No surprise then that lumber futures have plummeted from 70%, from $4.60 to $1.38 a contract, the lowest in 30 years. By the time you add up inventories of developers like Centex (CTX), Lennar (LEN), and Pulte (PHM), bank repossessions, and a gigantic overhang of anxious sellers desperately trying to get out of homes they can no longer afford, the number of houses for sale probably exceeds 5 million, or 8% of the total housing stock in the US, the most in 70 years. But the market thinks otherwise. The lumber industry has been downsized down to the bone through bankruptcies, mill closures, and distress inventory sales. So guess what happened in February when the trade never thought anyone would ever buy a stick of wood again? The Chinese showed up out of the blue as major buyers, triggering the ritual short covering rally, and chalking up two back to back limit up days in the futures market. Russia provided an assist by raising the tax on its lumber exports from 25% to 90%. Prices have recently settled at $1.85. I’m not by any means calling an end to the real estate crisis here, but lumber has suffered enough, and is a bargain. Smaller funds might consider using dips to accumulate longs. One futures contract get’s you 110,000 board feet of 2” X 4” soft spruce, fir, and pine in mixed 8’ to 20’ lengths, worth $20,350, about two thirds of a rail car full. With a maintenance margin requirement of only $1,650, the contract gives you 12:1 leverage. It’s a way to play the global demand for lumber without being held back by the continuing stress in American housing. If you don’t need the leverage, look at the biggest producers, Weyerhaeuser (WY), Rayonier (RYN), or Louisiana Pacific (LPX) which have already had huge moves. After seeing similar Chinese moves in copper, crude, and coal, this could be further proof of the beginning of a much broader, long term bull market in commodities.

May 06 05:40 PM

[David White:]

Marketwatch Article:
"Moody's Investors Service on Wednesday lowered Weyerhaeuser Co.'s (WY) senior unsecured debt ratings to junk status of Ba1 from Baa2. It also assigned a Ba1 corporate family rating and an SGL-1 speculative grade liquidity rating. The downgrade is due to the company's weakened financial position and the expectation that it will continue to face challenging industry conditions over the next 12 to 18 months, the ratings agency said. 'The company's weakened credit profile is principally due to its significant exposure to the protracted downturn in the U.S. residential construction market. We anticipate that the company's performance will remain challenged until U.S. housing starts recover towards trend levels,' Moody's said in a statement. The rating outlook is stable."

The same terrible quaterly results that caused this ratings downgrade also apparently caused the stock to go up yesterday. Apparently a lot of the losses were still one time charges. Still revenue has been shrinking rapidly. Plus WY did guide much lower for Q2 than had previously been expected. WY is now predicting almost double the loss that the market had been expecting. Of course, some of these items may again be one time items. However, when you consistently have huge one time item losses every quarter, there does come a time when the investor has to pay more attention to the GAAP result. The GAAP results for WY have been terrible lately. They seem likely to continue to be.

The one major caveat in all of this is the "China factor". It could easily turn out that the Chinese spur the lumber business dramatically as that economy really starts to gain steam again. Investors should watch for this.

Meantime there are good reasons the credit rating is now junk. This should make any buyers of the stock wary. It does not make enough from operations to cover its debt. Its debt is increasing as it loses substantial amounts of money each quarter. This cycle seems likely to continue throughout this year. It may continue throughout next year. As this process continues, it makes it harder and harder for WY to become a profitable enterprise in future quarters. Currently WY's net margin is -25%. That's just not good. It would be in the same boat as the car companies, except that it has tremendous real estate / lumber assets. The greater and greater debt is starting to tie an anchor chain around this company's neck though. If the market heads downward, this is likely a good stock to short. Otherwise, you might just consider taking your profits from the recent run up.

May 06 06:52 PM

[David White:]

Keep in mind WY lost $1.21B in Q4 (the prior quarter). A lot of this was in one time charges also. However, the bottom line is that it is all still debt. From the comments in the conference call, it seemed likely the loss next quarter would be as big or bigger than this quarter's loss (about $0.26B). Again a lot of these losses will likely be one time losses. Moody's is basing their evaluation on reality. I am not sure how the market is evaluating it. Some brokerages are still calling it a buy. When a stock's bonds are being called junk, I have to question this logic. When large one time losses occur every quarter, I have to question the market dismissing them as "one time losses". GAAP exist for a reason. This would be a good example of that reason.

May 06 09:25 PM

[donzelion:]

Author sees irrational exuberance. I see irrational desperation: traders and potential long investors are concerned about missing the bottom, because they've bought the gospel that 50-90% of returns from any market come from catching it. They're also overconfident about the ability of sell-stops to protect their assets should the market turn.

Weyerhauser is on a lot of radar screens, as analysts recall timber's performance during the 70s stagflation and look for proxies. Once it crossed their momentum thresholds, they all leaped in at once. It'll come back down to earth in months ahead...

May 07 05:59 AM

[TATyszka:]

Being skeptical about this current fool's bull doesn't necessarily make one a short seller or even a sideline watcher. I'm as bearish as anyone you'll find on this site, but that doesn't stop me from playing off the psychology of "investors" who feel otherwise. One simply has to be quick on their toes and take the profits as soon as they come, and then get out. HEB (a stock Mr White writes about today) is a stock I loathe. Ampligen is a vial of snake oil the company's been peddling for decades to no avail. But a check of the buzz and the recent chart action showed a possibility of some upward movement, no matter how warrantless. Monday morning I took a position at $1.74, and 28 hours later I exited at $2.40 with a 38% gain. I still think the company stinks and that the market bull is running on thin ice.

On May 06 09:32 AM friar tuck wrote:

> hey benard , you just gave yourself away as a short seller. eveybody
> plays with pain, if you can't, then sit the bench. put your money
> in a savings account and watch the caboose pull away. almost every
> stock out there is not only in pain they are are downright injured.
> getting released from the hospital is the first step of recovery.
> and that's all that has occured so far. it was unreasonable fear(GE
> AT 7.00???) that caused this crash and there's nothing wrong with
> a little unreasonable exuberence to balance everything out. do you
> think WY is just going to roll over dead?

Jun 03 08:50 AM

[David White:]

Relevant news Monday morning 6-8-09 EDT says that the deliquency reate for bank issued credit cards jumped 11% in the first three months of 2009 (to 1.32% in 2009 from 1.19% in 2008). This is negative news for the credit card industry. This might make me bet on COF, AXP, etc. going down Monday (and possibly more days).

Jun 08 01:19 AM