David Moenning's Daily State of the Markets: 7/8

July 8, 2008 9:04 AM EDT

Fannie, Freddie and FASB: A Tale of Woe

As long-time readers know, I am of the mind that whenever stocks reverse course in a big way, there is usually a pretty good reason behind the move. So, as the Dow moved from up 110 points to down 150 in less than an hour yesterday morning, my question was, "What the heck is wrong now?"

The answer wasn’t immediately obvious. Oil was down and the dollar was up. The news wires didn’t show any big story. Sure there was talk of expectations coming out of the G-8 meeting, but there didn’t appear to be any big news story acting as a catalyst.

However, a quick peek at the most actives list and I had my answer. Fannie Mae (aka Federal National Mortgage Assn or FNM) was down more than 20% and Freddie Mac (FRE) was off by about 18%. And the problem wasn’t isolated as the financial sector was being trashed again. So, now the only thing left to do was to find out what was causing the problem. Although there wasn’t a clear consensus at the time, it appeared that a report out of Lehman (LEH) was the source of the difficulty.
According to StreetAccount, "Lehman commented on the GSE's this morning... The firm noted concern among investors regarding a pending FASB rule change that would essentially require FNM to add $46B of capital and FRE to add $29B. Lehman says that following a conversation with FASB staffers, they believe contemplated changes include bringing on balance sheet, most securitizations that presently qualify for off balance sheet treatments."

So there you have it – more and bigger problems for the financials thanks to potential new FASB accounting regulations. Not only would the GSE’s need to raise substantial amounts of capital, the game of keeping the bad assets off the balance sheet would come to an end. Thus, the downward spiral in the financials continues. If firms have to bring bad assets onto their balance sheets, it would reduce their capital position and cause, yep, you guessed it; more writedowns – which, would prompt more capital raising. Which, of course, raises the question, will the capital keep coming? And THIS brings us right back to the solvency of the banking system.

While it may be a bit of a leap, the worry over the potential for another round in the credit crisis was the primary cause for yesterday’s selling. And while it was modestly encouraging that stocks did try to rebound in the last hour or so, the bottom line right now is that we are back to an environment that Art Cashin described best by saying, “We just don’t what we don’t know right now.�

We can hope that the government wouldn’t be so dumb as to bring about regulations that would create even more problems in the financial sector. But then again…

In looking at the rest of the market action, it was modestly positive that oil had its biggest one-day decline in a few weeks (August Crude futures fell $3.92). But, with prices closing at $141.37, it’s going to take several more big down days for anybody to feel particularly good about oil.

Turning to this morning, we don't have any economic data to review before the bell but we will get reports on Pending Home Sales and Wholesale Inventories at 10:00 am. In addition, we’ve got some Fedspeak to review today with Bernanke talking now about financial regulations and mortgage lending and Lacker speaking on the economy at 12:30.

Running through the rest of the pre-game indicators, the overseas markets are down hard across the board. Crude futures are lower by $2.39 with the latest quote at $138.98. Interest rates are moving down this morning as the 10-yr is trading with a yield of 3.1% right now. And finally, with about an hour before the bell, stock futures in the U.S. are improving and may open only a smidge lower. The Dow futures are currently off by about 23 points; the S&Ps are about 2 points under breakeven, while the NASDAQ looks to be about 3 points below fair value at the moment.


Stocks "In Play" This Morning:

News, Upgrades/Downgrades/Brokerage Research:

Marsh & Mclennan (NYSE: MMC) – Upgraded at Citi
Precision Castparts (NYSE: PCP) – Named top defense pick at Cowen
L-3 Communications (NYSE: LLL) – Named top defense pick at Cowen
Teva Pharmaceutical (Nasdaq: TEVA) – Added to Conviction Buy list at Goldman
Electronic Data Systems (NYSE: EDS) – Upgraded at Goldman
Everest RE Group (NYSE: RE) – Target reduced at Lehman
Arch Capital Group (Nasdaq: ACGL) – Target reduced at Lehman
American Intl Group (NYSE: AIG) – Target reduced at Lehman
Allstate (NYSE: ALL) – Target reduced at Lehman
Host Hotels & Resorts (NYSE: HST) – Downgraded at Merrill
Amerigroup (NYSE: AGP) – Upgraded at Merrill
UnitedHealth Group (NYSE: UNH) – Downgraded at Merrill
Western Digital (NYSE: WDC) – Upgraded at Merrill
MasterCard (NYSE: MA) – Target reduced at Morgan Stanley

Disclosure: Mr. Moenning and/or related firms hold long positions in: MA

Note: All earnings reports compared to Reuter’s consensus estimates

** For More of David Moenning’s Market Analysis, Stock Portfolios, and Trading Ideas, visit: www.TopGunsTrading.com

The opinions and forecasts expressed are those of David Moenning, President of Heritage Capital Management and Co-Founder of TopGunsTrading.com and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security or Heritage Capital program. No part of this material is intended as an investment recommendation. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any of HCM’s programs. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that investment objectives outlined will actually come to pass. Investors should consult an Investment Professional before investing in any investment program. Neither Mr. Moenning or Heritage Capital Management nor any of their employees shall have any liability for any loss sustained by anyone who has relied on the information contained herein. Mr. Moenning and employees of HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while this publication is in circulation. The analysis contained is based on both technical and fundamental research. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.


David D. Moenning
Heritage Capital Management
Main: 630-250-4700
Direct: 303-670-9761
email: DMoenning@HeritageCapitalManagement.com

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• Goldman Sachs Conviction Buy List
• Pending Home Sales
• Ben S. Bernanke
• Citi
• Morgan Stanley
• David Moenning

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