Thursday, August 14, 2008
five theories of JPM's one day freefall
Late Monday, J.P. Morgan Chase, one of America’s pre-eminent banks, disclosed an incremental $1.5 billion loss related to residential mortgages since the end of its second quarter. Its shares plummeted 9.5% Tuesday, wiping out more than $12 billion of market value. Other big U.S. financial stocks lost another $50 billion in value on top of that. A disproportionate and panicked response? That depends on your theory of why the shares actually fell. There are certainly no shortage of explanations. In fact, there are so many that J.P. Morgan’s one-day freefall makes a good case study on the futility of predicting the behavior of stocks. Let’s have a look at some of these theories and the arguments for and against them. Theory No. 1: The 10Q Spooked Investors The cautious, downcast language used by J.P. Morgan in the “forward-looking statements” section of Monday’s 10Q filing scared already jittery investors. Quick housing rebound? Nope. Losses in the commercial mortgage-backed securities markets? Probably. For: The 10Q is the best proxy for J.P. Morgan’s view of its business. When they say there is no bottom in the U.S. housing market, it is more evidence for a negative Wall Street to stay negative. Against: It is a 10Q, for goodness sakes. What is the upside for Jamie Dimon to sound bright or optimistic in a 10Q filing? “Underpromise, overdeliver” is the mantra for all CEOs wanting to keep their jobs–even when it comes to the 10Q. Theory No. 2: Prominent Analyst Claims Failure of Strategy Bank analyst Dick Bove published a note on Tuesday morning titled, “JP Morgan Chase: The Original Concept Is Not Working,” lowered his per-share earnings estimates through 2010 and cut his price target on the stock to $39 from $43. For: When Bove yells fire, investors run. He appears on CNBC all the time, is fiercely independent and has made a number of good calls. BankAtlantic’s recent lawsuit against him has actually added to his “street cred.” Against: Bove’s “maintain neutral” rating on J.P. Morgan didn’t change. And he didn’t cut either his estimates or price target by much. The thrust of his note’s argument, that the merger of J.P. Morgan and BankOne was strategically flawed, is almost irrelevant to the company’s current predicament. Theory No. 3: Trio of Analysts Turns Against Goldman Before the open Tuesday, three “star” analysts–including curmudgeonly “star” Bove, glamorous rising “star” Meredith Whitney and old-school “star” Michael Mayo–all downgraded the starriest of the star stocks, Goldman Sachs. For: Goldman occupies a hallowed place in minds of investors. If Goldman is now infected by the bear, Wall Street is convinced that no competitor, not even J.P. Morgan can be free of the contagion. Against: The Goldman calls are irrelevant. Goldman has consistently made research analysts who cover it look like nail-biting chumps. Besides, owning the stocks has a different logic. J.P. Morgan is a play on the resolution of the credit crisis. Goldman Sachs is a play on increased capital-markets activity. Theory No. 4: The Usual Correction on Profit-Taking J.P. Morgan stock bottomed at $29.24 on July 15. Monday, it traded as high as $42.81, an astonishing 46% increase from that recent low. It was an increase of nearly $50 billion in J.P. Morgan’s market value. Monday’s announcement of the losses provided a convenient pretext for investors to take profits. For: Occasional sharp corrections are an inevitable part of the bottoming process for beaten-down stocks. Investors believe the bottom was put in on July 15. That doesn’t mean the stock will continue uninterrupted upward. Against: Very few investors actually bought in at the July 15 low. Most prices paid for JP Morgan in the first half of July were close to $35. And in the second half of July and this month, prices were closer to $40. How much profit can there be? Theory No. 5: Wall Street’s Fast Money Goes Short Momentum investing rules Wall Street. Trading desks and hedge funds dominate day-to-day stock trading. Once J.P. Morgan’s shares were seen as vulnerable on Tuesday morning, the traders jumped aboard and pounded the stock. The imminent lifting of the SEC’s short rule restrictions (at midnight Tuesday) may have also emboldened the shorts. For: Stock prices on a given day are determined by traders not investors. Traders drive the volume. The recent report that GLG trader Greg Coffey turned his $5 billion portfolio over more than twice a day in May may be an extreme manifestation, but it is telling nonetheless. Against: J.P. Morgan’s daily stock price mirrors investor views on the prospects of J.P. Morgan and the credit markets. It isn’t a reflection on what hedge funds can do with their computers. Remember that J.P. Morgan’s shareholder base mostly is comprised of long-term institutional investors. So, that is five theories for J.P. Morgan’s decline Tuesday. There are undoubtedly more. The beauty of Wall Street is that it is impossible to conclusively prove any of them. And it probably doesn’t matter. The stock market will always be a mix of right and wrong theories, of the predictable and unpredictable, the known and unknown. In the end, only one thing matters. The price of a stock. Which is what it is. And today, J.P. Morgan is down another 3%.