A Scorecard of Market Destruction

By KOPIN TAN At least that asteroid didn't hit us. TEXT SIZE PRINT EMAIL DIGG SINGLE PAGE REPRINTS GET RSS Subscribe Now With these readers: LET'S BEGIN -- WE MUST -- WITH SOME GOOD NEWS: An asteroid big enough to level 800 square miles of land whizzed by but missed our little planet last week, and we're still alive. Here on Earth, however, the destruction wrought by relentless selling in the stock market is becoming painful to behold: The stock market has lost $2.6 trillion in less than 10 weeks. Spring training has barely begun and the Standard & Poor's 500 is already down 24% this year, compared with the 38% loss for all of last year. The Russell 3000 has lost more than $1.7 trillion since Feb. 13, more than twice the $789 billion economic stimulus Congress approved that day. Selling got so severe at one point that President Obama was moved to flag the market's cheap "profit and earnings ratios," and how "buying stocks is a potentially good deal" for long-term investors. Stocks fell 12 of the past 15 sessions. It might have been 13 if stocks hadn't mustered a sharp swerve higher late Friday afternoon, after the government reported 651,000 workers laid off in February. Total job cuts this recession reached 4.4 million as the unemployment rate climbed to 8.1%, worsening worries about rising loan defaults and more bank losses. Such sharp selling, however, increases the odds of at least a temporary bounce in the oversold market, even if a lasting rally and economic rejuvenation remain elusive. Bear-market bounces are transient but are nothing to scoff at. The last one, from Nov. 20 to Jan. 6, produced a 24% gain. So even as stocks finished Friday near their lowest level since 1996, traders dutifully covered their short positions. The Dow Jones Industrial Average fell for the fourth straight week, closing down 436, or 6.2%, to 6627. The S&P 500 suffered its worst slide since late November and its eighth loss in nine weeks as it fell 52, or 7%, to 683; it is 56% off its 2007 peak. The Nasdaq Composite declined 84, or 6.1%, to 1294, while the Russell 2000 lost 38, or 9.8%, to 351. Just how oversold is the market? Less than 5% of S&P 500 stocks are holding above their 50-day moving averages. Buyers could bite as the S&P 500 approaches -- and holds -- a widely-watched technical threshold near 650. Meanwhile, investor moods swing between desperate to resigned, and brokers tell of clients on the brink of surrender. The latest survey shows the market's bullish wing shrinking to 19% from 33% as recently as mid-February, while the bearish huddle swells to 70% from 39%. Last week, traders lunged at Treasuries, credit spreads widened, and the cost of insuring against bank defaults soared. Against such anxiety, the option market's blasé response might seem incongruous at first. Demand for puts isn't particularly zealous, and market fear as measured by the VIX volatility index is well below last November's panic high. But so many fund managers have already shunted their money from stocks to cash that there is less need to buy puts to protect their portfolios. And with stocks skidding 21% in four weeks, even bearish traders are bracing for a brief respite. A LITTLE BOUNCE IS EASY, BUT AN enduring new bull market is tougher to spawn. Retailers, thanks to discounters like Wal-Mart (ticker: WMT), last month saw their first sales uptick since September. But twice-bitten, thrice-shy investors want to see a likely end to the blight in housing, banks and consumer spending before they commit again. Just last week, Wells Fargo (WFC) cut its dividends 85% to hoard capital, while General Motors (GM) reported a 53% drop in February sales. Financial stocks fell hardest last week and could continue to flail as shareholders worry about encroaching government ownership. But that's not all, as fears percolate of a destabilizing international banking crisis. Unlike their U.S. counterparts, European banks grappling with flubbed loans to Eastern Europe are slow to book losses and raise capital. So far, the U.S. accounts for three-quarters of bank losses recognized globally, and doubts linger about the balance sheets of European banks. "While the U.S. has the resources to bail out its financial institutions, the same may not be said for many other governments," says Jonathan Golub, a former Bear Stearns strategist who now runs his own firm, Golub Market Insights. Belgium's short-term bank liabilities are roughly 285% of its gross domestic product, while the figure is 260% for Switzerland, 156% for Great Britain and 60% for France and Germany -- versus 15% for the U.S. Coaxing Americans to spend more also presents both a challenge and a conundrum. Americans had 20 cents of debt for every dollar of income in 1945, but that figure has since swelled to $1.20. During this span, "risky assets" like real estate, stock holdings and pension reserves had increased from 1.4 times the annual income to 4.7 times in 2007. To Jeff Lick, who manages Galt Investments, the U.S. has morphed from an "income earning culture" to one driven by asset appreciation. And in recent years, that growth "was a self-reinforcing positive feedback loop fueled by very high level consumption." Now that household wealth has been cut swiftly and severely, a negative feedback loop has begun that could take years to play out. "The reality is so much of U.S. household consumption and GDP growth over the last five years was stuff we simply didn't need or simply won't miss," Lick says. He expects Americans to save more, and thinks the outlook for consumption growth is bleak. That helps explain why government stimuli haven't quite managed to inspire the stock market. "Policy responses to this crisis are worrisome, especially U.S. actions aimed at supporting excess consumption and Chinese stimulus focused on sustaining excess investment," argues Stephen Roach, chairman of Morgan Stanley Asia. Too Little, Too Late: A 146-point bounce late Friday cut the Dow Jones Industrial Average's loss last week to 6.2%. But it remains at its lowest level since 1997. He thinks the U.S. needs to save instead and plow those savings toward infrastructure investment, alternative energy technology and human capital, while China needs to increase domestic consumption. Fighting this inevitable rebalancing will merely return us "to the very same strain of unbalanced economic growth that got us into this mess in the first place." SHARES OF CITIGROUP (C), WHOSE $237 BILLION market cap made it the fifth largest U.S. company just 17 months ago, broke the buck Thursday and dipped below $1. The good news: Pressure on shares could ease as some technical trades run their course. Citi had announced on Feb. 27 a plan to boost its tangible common equity by swapping new common stock for widely held preferred shares. Under the plan, certain preferred holders will receive 7.31 common shares for each preferred share. Once details went public, preferred holders expecting to receive a load of common shares began dumping the common stock, as did existing shareholders threatened with dilution of their equity stake. Adding to the crush were arbitragers and hedge funds that bought the preferred stock while shorting the common -- essentially betting the gap between the two will close. And it did. The spread between, for instance, Citi's preferred F shares and the swap's value, essentially 7.31 shares of the common stock, narrowed from 195% to around 10% Thursday. In this stretch, the common stock slipped from 2.46 to about 1, while the preferred stock jumped from 6.09. Trading volume in the common stock has surged more than 200%. Shawn Collins, a special-situations analyst at Susquehanna, estimates that 70% of that traffic swell was driven by the arbitrage trade. "This massive technical pressure on Citi's common stock should abate as the trading spread closes in on flat" -- and certainly when the swap is completed, likely by April. SPRINGTIME IS FERTILIZER SEASON, yet producers of potash, a potassium compound plants need for healthy growth, are mired in an inexplicably wintry chill. The fear: Potash prices will decline with farmers' ability to buy fertilizers, and financially strapped Russian rivals might slash prices too far. Just last week, Russian heavyweight OAO Uralkali cut prices by about 25% for certain Brazilian customers -- its first cut since 2006. The timing is especially regrettable ahead of industry talks to set prices with China, a big spender in fertilizer circles. As a result, shares of profitable potash producers like Potash Corp of Saskatchewan (POT), Agrium (AGU) and Mosaic (MOS) are plumbing depths 70% or more below their 2008 highs. Potash Corp, for example, trades at just seven times 2009 profits, well below the 14.6 times average for agricultural chemical companies, and well off historical multiples pushing 30 during the heady commodity boom when it was excessively beloved by the momentum crowd. At this point, short-term pricing risks -- and more belated analyst downgrades -- are more than adequately reflected in the cheap stocks. For a start, last week's Russian price cut was for a limited three-month period from March to May, and prices will be nudged up if demand stabilizes. It also helps that industry demand has surpassed capacity in recent years, and Potash Corp has started to restrain production to tighten the market. Farmers often order less fertilizer in times of financial distress, like the fourth quarter. But this also drives them to deplete their stockpiles, improving the odds of a spring thaw in the demand freeze. Fertilizer demand rarely stays depressed for long. Scrimping, or thriftier fertilizer application, ultimately lowers the crop yield, and lousier harvests improve crop prices and give farmers more incentive to fertilize. Longer-term investors can take comfort in the knowledge that many crop-planting, potash-guzzling countries -- like China, India, Brazil -- all have growing economies. And the planet's growing population will always need to eat. -------------------------------------------------------------------------------- E-mail: kopin.tan@barrons.com