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Seeking Alpha

Monday, November 12, 2007

Morning Report: Veterans' Day Brings No Peace


(Stocks in this article: AMEX: FXP, NYSE: CFC, NYSE: IBM, Nasdaq: COGN, NYSE: HBC, NYSE: TSN, NYSE: MA, Nasdaq: INTC, NYSE: BX, NYSE: DIS, NYSE: GS, NYSE: MS, NYSE: MER, NYSE: C, NYSE: PTR)

Veteran's day brings no rest for weary equity investors. Late last week, a topic of discussion surfaced regarding FAS 157 and its November 15 implementation. Some are warning that new rules for "Level 3" assets could bring another round of asset markdowns. This news combined with fresh warnings from HSBC (NYSE: HBC) and Countrywide Financial (NYSE: CFC) look to allow no break for financial sector woes. However, if the stocks show strength today as pre-market activity seems to indicate, it would be a great vote of confidence for value.

  1. Financial Sector Distress - A recent report by Royal Bank of Scotland Chief Credit Strategist Bob Janjuah detailed more risk for the sector. As detailed in Barron's and Bloomberg, Bob sees $250 to $500 billion in total credit losses before all is said and done. These estimates match up well with many others I've seen. However, Bob brought to light a risk perhaps less understood by the market, the risk posed by the new FAS 157 rule that goes into effect on November 15. He sees about $100 billion of risk set directly to this implementation, as firms are forced to follow the new rule to value "Level 3" assets, those of lowest liquidity and most difficult to value. This has raised concerns, and one must wonder if bank accounting departments have fully accounted for this change in recent charges. I would certainly hope so, since Morgan Stanley (NYSE: MS) was listed as the firm with the most Level 3 assets, as related to its shareholder equity at the end of Q3. Recall, MS is the long in my pair trade detailed on Friday. It's important to note that this category covers securities spread among many different types of underlying assets, not just mortgage related. However, if the credit crisis spreads further among these instruments, one could foresee more trouble. MS shares are higher pre-market. I found it interesting that Merrill Lynch (NYSE: MER) was listed as the firm with the least Level 3 assets-to shareholder equity, and I wonder if the SEC investigation regarding Merrill's dispersion of securities to hedge funds might have something to do with that. Does this mean new charges are in store? There's a chance, but I do not expect a new round for MS on Wednesday, and would be highly disappointed if that happened. This should not be a surprise to anyone, and heads should role if recent chargers now charge again. Remember, Morgan listed its remaining risk at $6 billion, but that may be limited to specific instruments. I want to note that this gives Goldman Sachs (NYSE: GS) a way out of its recent denials regarding pending charge possibility. It seems highly unlikely to me that Goldman will go through the entire "kitchen sink" Q4 without a charge. However, after the guillotine showed up at Citi (NYSE: C) and Merrill, corporate heads have reason to delay the inevitable, self preservation.

  2. Oil and Gold Turn Lower - Despite the counter statements from Iranian and Venezuelan officials, the Saudi OPEC minister's comment that the group would discuss a possible production hike at its next meeting has set oil lower today. I believe your PetroChina (NYSE: PTR) short will continue to work now.

  3. A New Way to Bet Against China (kind of...) - If you are looking for a way to bet against the Chinese market bubble, ProFunds Group has created the investment vehicle for you, kind of. The ProShares UltraShort FTSE/Xinhua China 25 ETF (AMEX: FXP) may be a better hedge vehicle against Hong Kong holdings than a bet on Mainland Chinese equity bearishness, since it is not tied to bubblistic mainland shares, but the cheaper Hong Kong traded group. Mainland shares are restricted to foreigners.

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