Dead Man Walking
Investors are a psychological and herd-driven bunch rather than rational and research-driven. Thank goodness, too, because that’s what gives rise to Elliott waves.
To wit, many stocks continue to trade even after their companies have declared bankruptcy, which means that the stocks will eventually end up at zero. Examples include Enron, WorldCom and Lehman Brothers. Today, we see companies continue to trade on substantial volume and have decent-sized market capitalizations, when, even by their own admission, they are likely worth nothing. Action in this type of stock raises our confidence that the entire 2009 rally was a speculative advance that will be completely retraced. Fannie Mae (FNM) for example, just this week took out its 2009 low, collapsing by two-thirds since June.
Yes, the same Fannie Mae that wrote in its 10-K, “It is highly uncertain that there would be sufficient proceeds to repay the liquidation preference of any series of our preferred stock or to make any distribution to the holders of our common stock.” Yet it still sports a $274 million market capitalization, despite admitting that it probably won’t even have any money to pay preferred, let alone common, stockholders. The NYSE delisting announcement was a wake-up call to those who continue to hang on, and FNM holders aren’t alone in their delusions.
Take a look at a quote from Ambac’s (ABK) recent 10-K, “Ambac has insufficient capital to finance its debt service and operating expense requirements beyond the second quarter of 2011 and may need to seek bankruptcy protection.” So, in other words, Ambac has less than a year’s worth of cash, yet, as recently as April 2010, shareholders placed almost a $1 billion value on the company’s shares. Today, that value is down to $188 million -- it seems they are wising up somewhat.
Lastly, let’s look at Huntington Bancshares (NASDAQ:HBAN). It is a mid-sized regional bank based in Ohio. This stock topped back in 1999, and even during the salad days of the credit bubble it was unable to best its former high. Another vicious decline left its stock worth a single dollar in 2009.
So why do we think this rally up to 7.40 in April 2010 will be completely retraced? Although the wave patterns of individual stocks often require some leeway (see Elliott Wave Principle, pg. 169), the rally from the February 2009 is tracing out three waves, the signature of a correction. It has reached the minimum 23.6% retracement of the third-wave decline and the area of the previous fourth wave.
It's obvious that these companies have a high degree of risk to begin with, but we think that wave counts show corrections that make them even riskier to invest in. Like the 1995 movie “Dead Man Walking,” which follows a death row inmate's final march, these companies appear to be “Dead Companies Trading.”
Disclosure: Long Puts on HBAN