Monday Market Update

Market Commentary:

The DOW is a sorry sight this week. Bank stocks were hammered early today, setting the tone. The DOW suffered the most, reaching new lows and closing at levels not seen since October of 1997.

It’s all about the banks! Citigroup looks poised to go under and Bank of America looks like it is second in the queue.

I’ll get right to the point.

Just last week Treasury Secretary Timothy Geithner announced the new Financial Stability Plan. Since that announcement Citigroup has fallen as much as 59% (at one point today), recovering a bit on late day buying but still managing to close down 51% since the Stability Plan was announced.

Bank of America fared even worse at the lows of today, down 63% since Geithner’s announcement. But the late day buying helped Bank of America the most, recovering a huge early sell-off and ending the day down 46% since the Financial Stability Plan was brought out.

You see, the stability plan was full of more holes than a stainless steel strainer. And the big lump in Geithner’s throat as he announced the plan was his startling declaration that somehow they were going to entice private capital to participate in this stability effort.

On the surface, at least, it appears the administration’s new Financial Stability Plan has created far more instability than stability.

What happened today clearly demonstrates why the banking stocks are tearing the stock market apart, especially the financial sector and the DOW index, in particular.

Senate Banking Committee Chairman, Christopher Dodd, was interviewed on Bloomberg Television and said that some banks may have to be nationalized for a short time, a move he wouldn't "welcome at all" but "could see how it's possible it may happen."

Market selling took off as word of the interview leaked out.

At first glance, nationalization might seem only natural, given how the TARP monies have been used so far by buying up shares in banks and other financial institutions. But take a little time to study the implications and you will better understand the investor fear that dominates the banking sector.

The expectation of bank nationalization is that the current shareholders would be left unprotected – that the government bailout monies infused into the banks would buy shares of stock that would be “preferred” over the common stock holder shares.

If you are an investor in bank stocks, how do you feel? If you think the government is planning on bailing out the banks you hold shares in and putting you at the end of the line, are you willing to follow the principles espoused by Geithner and plow some more money into banks so you can stay at the end of the line when and if the banks finally make good?

How can these two opposites co-exist? The administration talks about luring private capital for banks in their bank stabilization scheme and yet the very aspect of nationalization that is occurring raises serious fears among private investors that they are going to be left out in the cold.

Of course the market is crashing around the banks. The missing details in the “Stability” plan are so obvious that bank investors are truly running scared. You have heard it said many times, “The market hates uncertainty”. Well, uncertainty is exactly what has been delivered so far.

But an interesting change happened later in the day that caused the markets to rally strongly, especially bank stocks. The Obama administration was forced to come out with an announcement countering Dodd’s interview, saying it prefers and supports a private bank system.

" This administration continues to strongly believe that a privately held banking system is ... the correct way to go, ensuring that they are regulated sufficiently by this government," said White House press secretary Robert Gibbs.

" That's been our belief for quite some time, and we continue to have that," he told reporters at the regular White House briefing.

Does the right hand even know what the left hand is doing?

Bank of America stocks recovered nicely, rallying from being down -36.9% to close the day down only -5.5%. That is a nice 31.4% difference, folks!

The simple certainty from the administration that private banks were a preferred approach gave investors confidence to begin buying once again.

That is the sort of thing that needs to be done in so many different areas – simple sticking points that will establish a known base line.

Simple things like changing the “mark to market” for mortgage backed securities, at a time when absolutely no one knows real market values of these instruments. By stating the asset at its face value unless default occurs the banks are not forced into what may be arbitrary valuations and ratios.

Another long-proved and helpful rule was the “up-tick” rule, where a short position could not be placed until there was an up-tick in the stock, slowing the strong hammering that has happened so often in the financial stocks over the last 18 months.

These are just two simple things that would lend “certainty” to the financial sector. I am sure there are hundreds of other simple ideas that don’t cost a trillion dollars – many a lot better and more effective than these two.

The point is that by leaving so much uncertainty, the stock market is left no recourse other than pare down and pare down until things become more certain.

Technically, the largest of the large caps, the DOW has broken down through the November lows, the 2002 recession lows, and gone clear back to 1997. However, the Nasdaq, the NYSE, the small caps, and even the S&P 500 remain a long ways from the 2002 lows and some are even a long way from the recent November lows, leaving us with an unusual bullish divergence.

Today started out and looked like a real slammer of a day – and yet, after the simple pronouncement from the Obama administration, a very nice recovery rally softened much of the day’s losses.

Will it continue, though? Have the short positions been scared into more short-covering over the next few days? Or is more obfuscation and uncertainty from the government on the menu next week?

Do you need a good laugh?

I just read that President Obama is hosting a Fiscal Responsibility Summit this coming Monday at the white house, where selected members of Congress, financial analysts, economists and community leaders will huddle to discuss long term ideas for keeping the government’s books sound. I didn’t catch whether Bank officials were invited.

" The summit's a first step in the process of beginning to lay out how we can bring down the deficit and put our economy back on sound financial footing," White House press secretary Robert Gibbs said on Friday.

Summit participants aren’t expected to announce any policy moves – let’s hope so! The less said the better, in my opinion.

As a wise man once wrote in Proverbs, “Even a fool, when he holdeth his peace, is counted wise: and he that shutteth his lips is esteemed a man of understanding.” (Proverbs 17:28)

I like the more common version: “Better to keep your mouth closed and and be thought a fool than to open it and remove all doubt.”

A very nervous and uncertain market could collapse into another hard bearish leg down or could suddenly rise from extremely oversold conditions – but my crystal ball is snowy and hard to see through.

Remain defensive.