Russell stumbles on GSE crisis, record crude oil
Small-cap stocks plunged early Friday as a downward spiral developed among government-sponsored mortgage firms and record high crude oil prices sent equity bears on a stampede. At 10:00 a.m. ET, the Russell 2000 (NYSE:IWM) was down 3.09, or 0.46%, at 667.35, an ugly start to the day, but well off the initial morning lows.
The Michigan sentiment survey came in better-than-expected, with the headline figure at 56.6, compared with the median forecast of 55.5. The stock market appeared to bounce mildly off the lows in conjunction with the Michigan figures, but the market was already trying to mount a recovery move even before the data came out.
Fannie Mae (NYSE:FNM) collapsed some 40% shortly after the open, and similar losses were pinned on Freddie Mac (NYSE:FRE) on huge trading volume. Selling fury was fueled overnight by an article in the New York Times suggesting the government was considering a takeover of the embattled mortgage lending giants as the housing slump and credit crisis wallop the firms.
The freefall in GSEs spilled over to the rest of the financial sector, with large caps such as Wachovia Corp. (NYSE:WB) down 9%, Merrill Lynch down 6% and Lehman Bros. (NYSE:LEH) off 17%. Small-cap index products are peppered with regional and small banks, and they often have even more trouble gaining access to credit than the bigger banks, so heightened fears on the credit crunch could slice into the outperformance seen in the Russell 2000 versus large-cap index products (although in early trade, losses in the Russell 2000 were on a slower pace than its big-cap brethren).
“Retail and credit issues sparked selling yesterday and remain a concern today. Volatility is high right now. I think FNM and FRE are vulnerable to further losses, but the market is thinking that the government will aid the GSEs in some way and keep the financial system whole,” Nick Kalivas, vice president of financial research with MF Global, told SmallCapInvestor.com in an email interview.
“I think earnings news should be the main focus and Thursday’s DOW/ROH deal was bullish, but the credit environment is so uncertain and the market does not see the financing available for a host of deals. The market is cheap based on the M&A, but there may not be the liquidity or money to actually push it higher. That deal is kind of like a one-hit wonder right now,” Kalivas said.
Small caps were able to outperform large caps during Thursday’s bounce, but Kalivas said the move was powered more by a recovery in oil and natural gas that sparked money pouring back into small-cap energy firms. “I think it is more a beta trade or a sector trade than a sign of the market’s overall health. I’m not reading much into it,” he said.
The explosion in crude oil prices to fresh record highs this morning will likely be a bitter pill to airline carriers, package courier firms and other businesses with heavy exposure to fuel costs. Crude oil prices jumped nearly $5 dollars a barrel early today, soaring above $146 dollars, and recouping $10 dollars of losses from earlier this week in a dramatic fashion ahead of the weekend. Energy markets caught a bid on concerns about potential supply disruptions out of Nigeria, where a militant group said it was abandoning a cease-fire and also out of Brazil, where a worker strike looks set for next week. What’s more, geopolitical tension out of the Middle East remains ramped up, with Iran test firing missiles and Israel supposedly threatening to attack Iran’s nuclear facilities. It’s a backdrop that made it difficult to hold short positions in crude oil into a weekend.
From an equity market perspective, airlines were taking a hit right off the bat this morning, with the AMEX Airline Index down about 5%. Continental Airlines (NYSE:CAL) was off about 8% right after the open, while Delta Airlines (NYSE:DAL) was down about 5%. Small-cap carrier US Airways (NYSE:LCC) was down about 5% as well.
The combination of GSE downside drama and soaring crude oil prices completely overshadowed a decent earnings report from General Electric (NYSE:GE), which is often considered a nice proxy for economic health. GE shares were down 0.3% shortly after the opening.
Among broad market sectors, thrifts and mortgage finance firms were in full collapse mode this morning. Also on the downside were IT consultants, consumer finance, investment banking, diversified banks, regional banks and specialized finance firms. Bucking the downdraft were brewers, gold, coal and oil stocks.
Small caps on the move this morning included Big 5 Sporting Goods Corp. (Nasdaq:BGFV), which gapped lower and was down about 10% to fresh 52-week lows. MGIC Investment Corp. (NYSE:MTG) was down 13%, also at new yearly lows. Audiovox Corp. (Nasdaq:VOXX) was down 11% on earnings news. Repros Therapeutics (Nasdaq:RPRS) was up 11%, gapping higher on news that the firm’s uterus pain drug had a successful mid-stage trial.
Although it’s hard to stomach right now when the market is roiled by fear, uncertainty and sinking prices, it’s interesting to note that volatility has ramped up noticeably this week. Why is that worth mentioning? Until this week, the decline off the highs had been relatively calm, without the spike in volatility we might expect. Now that volatility has ramped up at these levels, it’s worth noting that volatility was also high when the market bottomed back in January and March. All that said, predicting a bottom here without a dynamic reversal chart pattern is akin to trying to catch a falling knife. A weekly close below 660 would wipe out long equity and keep tremendous heat on losing shorts while maintaining a bearish chart structure.
