RealMoney Silver - April Fool's Joke Is on Investors

April Fool's Joke Is on Investors
By Tim Melvin
RealMoney.com Contributor
4/2/2008 2:16 PM EDT

Wall Street threw an April Fool's Day party with a massive rally on Tuesday. As I have made no secret of the fact that the only thing I like less than the stock market are my Orioles' chances of losing less than 100 games, I had to take a deeper look at what was causing the huge rally.

The biggest headline under market news Tuesday was that the stock market was rallying on bank news and improved economic reports. Fear has left the market, as reflected in the CBOE volatility index's recent drop of more than 50%. Since I seem to be the only one even marginally afraid, I went and read the reports on the economy and the banks to see what I was missing.

I don't think I missed a thing. Are you telling me that UBS (UBS) losing $19 billion in asset writedowns is a reason to rally? The stock was up more than 15% Tuesday on news that it received a $15 billion capital infusion.

This is not good news. The capital infusion is dilutive to current shareholders and they had to raise the capital. This is not money to expand and grow; it is cash to plug massive losses in the balance sheet. The bank still has over $30 billion of exposure to U.S. subprime and alt-A mortgages.

Deutsche Bank (DB) estimates that it will take more than $4 billion in asset losses from commercial and residential real estate as well as leveraged transaction loans. Lehman Brothers (LEH) sold $4 billion of convertible preferred stock to quiet its critics. To make investors feel better, the investment bank diluted current shareholders' equity by 15% and raised its dividend expense by $269 million. Company officials said that the offering was not to shore up its balance sheets but to assure critics that it had the confidence of the investment community and is a viable institution going forward. This is quite philanthropic of them, unless you are a current shareholder or care about future profits.

In a final piece of good news for financial stocks, Goldman Sachs raised its loss estimates for both Citigroup (C) and Merrill Lynch (MER) for the first quarter. The analyst also cut the full-year earnings forecast for Citigroup by 60% and Merrill by more than 80%. I cannot believe I missed these positive signs for the financial sector and did not buy stocks up to my full limit! Using the same logic, I guess I should get on the playoff ticket list now as well, since the World Series will surely be played in Baltimore since we cannot hit, pitch or field very well. (Yes, I am using a lot of baseball metaphors this week. Don't worry, by May we will be 10 games out and I'll cut back quite a bit.)

What did I miss in the economic reports? Again, I don't think I missed a thing. The industrial sector fell for the second month in a row. Norbert Ore, the chairman of the ISM committee that that conducts business surveys, pointed out that this was the worst quarter for U.S. economic activity since 2003. Perhaps that means it is bottoming and brighter days are ahead? Ore pointed out that there is continued weakness in new orders and that order backlogs are declining. Keep in mind that the 2003 low was reached after we exited a recession, not before we entered one.

The other piece of good news Tuesday morning was that construction spending dropped again. Residential real estate construction activity has dropped every month now for two straight years, an unprecedented streak. In spite of this, the inventory of unsold homes remains well above average and will likely continue to be as the record level of foreclosed homes comes into the market over the next several months.

Commercial construction activity also contracted for the third straight month. Government construction spending rose, but nowhere near enough to offset the residential and commercial declines. If all of this is good economic news, things are worse than even I thought.

Stocks rallied because of news from the banks and the economic front. Not only does the emperor have no clothes, he is not looking too healthy and seems headed for a fall. So is the stock market.