by Houghton and Atkeson 05/15/08
Editor's note: While Sam Collins is on vacation through May 15, OptionsZone.com contributors and professional traders Andrew Houghton and Nick Atkeson are taking over the Daily Market Outlook as guest columnists.
Things seemed to be going very well for the bulls until shortly after 2 p.m. yesterday A second attempt at the day's highs, hit only some 45 minutes beforehand, failed and the market proceeded lower from that point -- giving up 11.53 of the 17.15 S&P 500 (SPX) points it had gained to close at 1,408.66, which was 5.62 points higher than the previous day's close.
Stock investors seem to remain confused and jittery, and the CBOE Volatility Index (VIX) was the perfect reflection of the S&P moving lower for most of the day and then higher after 2 p.m.
With this kind of move upward and no major news event to act as a catalyst, what causes the market to give up most of that upward progress so quickly?
AN 'OUTRIGHT DEBACLE'
We think one of the answers can be found in a recent article in the International Herald Tribune by Andrew Ross Sorkin in which Ken Griffin, founder of Citadel Investment Group was interviewed.
When asked how we got into the mess we're in, Mr. Griffin replied as follows:
"Walk across any of the trading floors -- they are filled with 29-year-old kids. The capital markets of America are controlled by a bunch of right-out-of-business-school young boys who haven't really seen that much. You have a real lack of wisdom."
He also noted in the interview that many chief executives of big universal banks, the ones that combine all sorts of financial services under one roof, "only understand a small part of the business" (e.g., sales).
The bottom line, then, as Sorkin summed up, "Put these two things together … and you have the making of an outright debacle."
HOW CAN WE RESTORE EQUILIBRIUM?
How this relates to yesterday afternoon's market action and the action of the markets since the credit crisis began in earnest is that you have a lot of young, inexperienced people managing risk in an environment that, as the media is so quick to repeat ad nauseam, we haven't seen in upward of 50 years.
Add to -- or, really, subtract from -- this the amount of capital on the sidelines along with the decrease in leverage, and you get the skittish markets we saw yesterday afternoon and have seen since the start of 2008.
Having said this, the markets will correct themselves, as they always have. A couple of days ago, the credit market took another step toward recovery, with American International Group (AIG) raising a huge amount of capital -- $4 billion of junior subordinated hybrid bonds that mature in 60 years -- after reporting horrible numbers.
To put this number into perspective, a normal day's worth of corporate bond issuance is $3 billion to $5 billion. AIG did that all by itself.
In addition, we saw upward of $13 billion in new corporate bond deals come to market yesterday. That's the sixth day of more than $10 billion in daily issuance in the last month. We cannot ever recall such a string. Along with the higher-quality names that began this surge, now we are starting to see more junk issuance.
WHERE DO WE GO FROM HERE?
The action in credit is now a significant positive. Capital is flooding into corporate Treasuries, and this will be put to work, raising the potential for a strong run in stock prices if we can clear the S&P's 1,405 area and hold it for a week or so.
If credit remains like this, more and more non-financial firms will be boosting their buybacks this summer, and that would lead to some leveraged buyouts (LBOs) this fall. As most equity investors do not seem to have embraced this view -- as has been the case with most bottoms of the last five years -- stock investors would be dragged kicking and screaming into the market.
So, while this bond action cannot prevent stocks from breaking below S&P 1,390 in the short term, it does make a move to the highs more likely.
Andrew Houghton and Nick Atkeson work together to identify unusual options trading activity on the "big money" (i.e., institutional) level and regularly contribute their findings to OptionsZone.com.
For a timely look at big-money options trades taking place under the radar and independent of the headlines, visit Andrew and Nick's full archive of Unusual Options Trading Activity by clicking here now!
