GSE takeover prompts financial-led rally
Small-cap stocks rallied Monday, but most of the fireworks took place in the morning as the market awoke to news that government-sponsored enterprises Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) had been taken into conservator status by the government. There was an initial euphoria that pushed small-caps up some 3% in after-hours trading, but the market drifted well off the highs through midday as tech stocks continued to fret about the possibility of a global slowdown. An afternoon push in the final 30 minutes of trading helped lift the Russell 2000 (NYSE:IWM) to a gain of 14.01, or 1.95%, at 732.86; the small-cap benchmark is now down just 4.3% for the year. Meanwhile, the Dow was up 2.58% and the S&P 500 was up 2.05%. For 2008, the Dow is down 13.2% and the S&P 500 down 13.6%.
The market spent much of the day trying to decide if the Treasury Department’s takeover of Fannie Mae and Freddie Mac represented a long-term positive, or just a short-term stop-gap measure. Clearly, the outside world loved the news, as equity markets in Asia and Europe posted strong rallies overnight. There was a sense among investors that the government was basically forced to take this action, and that it would help pull some of the uncertainty out of the equation when it comes to trusting mortgage-related debt issues. Still, it’s a big leap from shoring up paper mortgage-backed securities debt to finding a bottom in the housing market slump.
In a research report earlier today, strategists at Goldman Sachs said that the GSE plan was a short-term bullish factor for equities and the U.S. dollar. “The move is consistent with the U.S. administration’s main aim to secure financial stability first, in the spirit of the Bear Stearns bailout in March and the declaration of the unusual and exigent circumstances by the Federal Reserve Board,” Goldman said in an email report.
“At the top line, from the equity trading strategies side, we see the GSE package as a clear short-term positive for equity index risk broadly, as markets respond to the reduction in both systemic tail risks and the potential deepening of the credit crunch. While the last few months of equity pressure have been more about economic than systemic risk, we think stocks could bounce quite vigorously in the short-term, even if many of the underlying headwinds remain. We also maintain a preference for domestic-facing cyclicals against foreign-exposed ones in the US market. The GSE package reinforces that view, particularly if we are right that it ends up USD-positive, and may add to the recent pressure on long energy/short financial positioning,” Goldman’s research note said.
Clearly, financial stocks — particularly banks — embraced the GSE takeover. The Financial Select Sector SPDR Fund rose 4.3% and the PHLY KBW Banking Index climbed 6.9%. The nation’s biggest bank, Citigroup Inc. (NYSE:C), rallied 6.4% and the number two bank, Bank of America Corp. (NYSE:BAC), jumped 7.7%. Interestingly, American International Group Inc. (NYSE:AIG), which was up 10% ahead of the open in after-hours trading, actually only gained about 1.8% for the day.
Despite the positive glow from the GSE news, tech stocks never really did warm up to the overall buying euphoria. The tech-laden Nasdaq 100 shed 0.30% on the day, as investors continue to worry that a global economic slowdown could crimp spending on technology.
Crude oil prices slipped to five-month lows during the session, but eventually clawed back into positive territory by the U.S. trading close as energy bulls worried about Hurricane Ike and the bears pointed to a surge in the U.S. dollar (which makes dollar-based assets like crude oil more expensive to buyers). The dollar pushed to 11-month highs against the euro, soaring some 150 basis points, or more than 1% in the process.
Individual small caps of note today were highlighted by Gehl Co. (Nasdaq:GEHL), which soared 116% on news that the firm would be bought by French company Manitou for $331 million. Builders FirstSource Inc. (Nadsaq:BLDR) rallied nearly 14%, apparently benefiting from the GSE news. Champion Enterprises Inc. (NYSE:CHB), jumped 21%, rising to the highest point since late June. On the downside, Biodel Inc. (Nasdaq:BIOD) was off 67% on disappointment linked to a clinical trial for the firm’s diabetes drug.
Looking at the chart picture today, the ability to close above 726 was important for the Russell to validate the rally this morning. In addition, the daily patterns remain bullish off Friday’s big intraday reversal from the jobs data scare. Looking ahead to Tuesday’s session, the market still faces resistance at 742, then at 748. On the downside, any probe through 726 support opens the door to a run on 720.50 support.
