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Market Wrap-up: turning ugly for the first time this year

|Includes: Alcoa, Inc. (AA), INTC, MU, WDC

 Things turned ugly (on a relative basis… nothing compared to last year’s corrections) in the market for the first time since the beginning of the new year, after Alcoa’s earnings miss (AA was down 11% for the day in reaction to the poor results overnight and following analyst downgrades) and profit warnings or poor results during the day put investors on the defensive.  The recent run-up in stock prices anticipated a strong quarter, but early reports reveal a still-weak economy.  On top of poor earnings reports, news that China was moving towards tightening monetary policy much sooner than expected further supported concerns weak employment and consumer credit reports last Friday.  In an effort to control inflationary pressures and signs of bubbles, the Chinese are requiring that banks hold more cash reserves against deposits, which means that the multiplier effect of the financial system – and thus system liquidity – is going to decline.  The tightening will likely impact commodities and exporters the most.

Investors may also start taking a more defensive position in their portfolios (read: selling and shorting) in advance of the slew of earnings by financial companies over the next couple of weeks.  According to recent memory, banks have been running up into earning and then investors have “sold the news”, even if it was positive.  Stock price action has some elements of déjà vu.  In addition, the government is overlaying headline risk on top of what is feared to be another “kitchen sink” quarter. 

Banks will take a thorough look at their books and try to bring forward charges so as to have an easier 2010, since investors are looking forward and may forgive a peak-loss quarter (as long as things are improving hereon forward).  Especially for banks that are expected to lose money, they have an incentive to take even more charges and take advantage of look-back tax benefit provisions before they expire.  At the same time, the FDIC considers making banks pay more fees if they tie compensation to risky practices, while the White House is working on taxing banks in order to recoup TARP-related losses. 

The losses from the $700bn Troubled Asset Relief Program (TARP) were pegged at around $140bn in early December, but earlier this week the Treasury revised estimates to $69bn, including $30bn for AIG, $30bn for the automakers, and $27bn for the Home Affordable Modification Program (HAMP).  Banks are directly responsible perhaps for the HAMP program losses, but offsetting those are the $19bn of profits to the Treasury from bank capital injections and investment programs.  So, the net loss due to banks may be only $8bn, yet news reporters say banks may be on the hook for up to $100bn to help balance the government budget.  It may not make sense, but stranger things have happened and, if we have learned anything in the past, there is little point in speculating what the government will end up doing, not implying that its actions may not make sense but rather that the forces that it has to balance are so intertwined and the situation so complex that unexpected actions come about.

As expected, following the trigger-miss by Alcoa and Chinese monetary tightening that impacted commodities (the CRB commodities index was down 1.7%), the Materials sector was the worst-performing for the day, down 2.6% compared to a decline of 34 bps on the Dow, 94 bps on the S&P, and 130 bps on the Nasdaq, which is continuing an under-performance streak so far this year).  Financial stocks also had a very rough day due to headline risk and “sell the news” concerns around the earnings season.  Tech stocks have had a nice run-up, so investors are locking profits in anticipation of “sell the news” action and to protect against outlook warnings in advance of Intel’s – INTC earnings release coming up on Thursday.  Semiconductor companies like Micron Technology – MU and SanDisk – SNDK were down 5-6%.

Disclosure: No positions