Wall Street Greek: Flighty Financials Threaten Stock Market Correction

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This week's copy of Barron's highlighted some substantial concerns that we believe may help serve as catalyst to a stock market correction (or crash) this week. Several articles within this week's copy of Barron's, arguably the most important financial markets publication (and therefore widely read) that your newspaper stand has to offer, raised serious concerns that important investors are likely considering this morning.

Stock Market Correction

Asian markets moved sharply lower today, and European shares quickly followed their lead. Speculation filled, retail supported Mainland Chinese shares led the way lower, as the CSI 300 moved down 7.11%. The most attributed reason has been a sudden reconsideration of valuation, which coincides with market skeptics most commonly cited global concern. The word goes, we've come too far too fast and are due for reconsideration.

A Look at Global Markets:

China's CSI 300: -7.11%
Hong Kong's Hang Seng: -1.86%
Japan's NIKKEI 225: -0.4%
Broader Asia's MSCI Asia APEX 50: -1.6%
South Korea's KOSPI: -1.0%
India's BSE SENSEX 30: -1.6%
DJ Euro STOXX 50: -0.75%
CAC 40: -0.7%
DAX: -0.67%

Flighty Financial Stocks Pulled the Market Too High

We would normally brush off this Asian market start as something most likely to be quelled by US trading, if not for good reason for concern right here at home. Barron's pointed out a few notable reasons for issue, not least of which is the legendary seasonal weakness of September/October. Barron's discusses the beginning of pre-announcement season for the coming year's forecasts. This is when companies begin taming analyst forecasts, or for the layman, making them more manageable. Stocks adjust along with earnings expectations, thus the importance of P/E ratio. However, at this point in the economic cycle, one would expect analysts' forecasts to already be somewhat tame.

We are more concerned by the fact that traders have been moving the market in large proportion on speculative interests. Barron's Michael Santoli noted the Wall Street Journal's Friday scribblings on the importance of five low-priced stocks on overall market movement. Apparently, Citigroup (NYSE: C), Fannie Mae (NYSE: FNM), Freddie Mac (NYSE: FRE), Bank of America (NYSE: BAC) and AIG (NYSE: AIG) accounted for 31% to 43% of daily trading volume last week. Traders, both retail and professional, tend to cause impact like that, and it's not representative of long-term market direction. But, has the broader market been led astray anyway?

Well, stocks are up more than 50% since the March low. Some of that rich profit is deserved, and due to the extreme panic that had driven stocks below sensible consideration. Still, some of these low-priced shares moving the market only exist now because of massive government intervention, ownership, and as a result, shareholder dilution. Last week, a trend savvy but finance education absent friend of mine pointed out his prescient investment advice on FNM and C. When that happens, I raise an eyebrow. It's akin to a stock tip from your auto mechanic in high times.

I remember when a cousin of mine pumped the destined-for-bankruptcy General Motors (NYSE: GM) to me at a family event not too long ago. When I told him that shareholders would be left holding worthless shares, he could not comprehend it. His face filled with confusion and even anger toward me, as he had to go for a walk to contemplate the possible risk to his investment if I was right. He thought GM's bailout meant he should buy the stock, not realizing that a new company would emerge with new shares and shareholders (those mostly being public and union owners as per the reorganization). I hope that cousin of mine trusted in my advice and sold while he could, but these are examples of people acting on incomplete knowledge. This is why my MBA and Wall Street experience are worth a dime.

When shares are considered to represent the absolute reflection of asset value, and not understood as market-priced instruments, people can fall into these traps. This is why companies that are clearly destined for bankruptcy still trade above zero after the announcement. So, I think Santoli is right when he implies the broader market may be following these speculative financial cripples, taking a great majority of stocks above their 200-day average. This is a warning flag.

Barron's Alan Abelson noted that "examples of the spirited revival of investors' mindless pursuit of risk abound." He speaks of the great interest in and resulting share price rise in Fannie Mae, Freddie Mac and others. Stocks are not toys to be played with, but financial instruments that are market-priced by both savvy market manipulators and foolish retail masses. This is why doing your homework matters. Abelson points out AIG's rocket rise post its reverse stock split (another gimmick that fools the foolish). Its shares are up more than 300% despite owing the government 25 times its market value. In other words, it's effectively bankrupt without Uncle Sam's gracious generosity. So is it then saved by Uncle Sam's intervention? When I hear Ben Bernanke's remorse (disgust is more like it) toward AIG, I'm not so sure, and it's not a risk I would bear.

On page 19, Andrew Bary writes about Citigroup's (NYSE: C) charade. He says, "Citi isn't a bargain anymore," and he ain't kidding... The government's massive interest use to be represented in C's share price, but recent speculation says something else to me. Bary notes that firms without government interest (nor TARP funds to hamper their actions) trade for equal to less than Citi, and he rightly suggests that C holders might better consider trading their shares for those of JP Morgan (NYSE: JPM) or Morgan Stanley (NYSE: MS).

However, with the broader market benefiting from this foolish speculation, a broader market retrenchment seems likely to coincide with severe correction in these five foolishly buoyed financials. The five clunkers should drop significantly more than the broader market in any reconsideration. What I don't get is why investors would not shop exclusively for real value when there's a market full of it now. I also do not understand why insects swarm to their definite death at the bug zapper though.