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Subprime Drama Sinks Stocks

Aaron Task

The subprime chickens came home to roost again Tuesday, despite some early morning crowing from Wall Street's prized rooster.

Blowout earnings from Goldman Sachs (GS Quote) helped to contain early losses despite a weaker-than-expected February retail sales report. But Goldman's strong stance was ultimately overshadowed by more drama in the subprime space.

The Dow Jones Industrial Average closed down 242.66 points, or 2%, to 12,075.96; the S&P 500 lost 28.65, or 2%, to 1377.95; and the Nasdaq Composite shed 51.72, or 2.2%, to 2350.57.

Fueling the selloff were the latest developments in the rapidly deteriorating business of lending to homebuyers with weak credit histories:

Goldman's morning glory helped contain the early negative response to the subprime woes, as major averages were initially down modestly. But the wheels came off after the noon release of the Mortgage Bankers Association's report on fourth-quarter delinquencies and foreclosures. The data showed higher-than-expected overall delinquency rates and a four-year high for the subprime category.

Selling accelerated in reaction to the data, and major averages closed just a hair above their worst levels of the session. (Programming note: Tonight's Real Story podcast features an exclusive interview with Doug Kass of Seabreeze Partners, who helps break down today's selloff and the implications of the subprime debacle, about which he has strong feelings .)

The selling was intense and widespread, approaching the drama seen during the week of Feb. 26. In NYSE trading, decliners led advancing stocks by 27 to 5, and down volume was 94% of the 3.5-billion-share total. In Nasdaq activity, decliners led advancing stocks 5 to 1, and down volume was 88% of the 2.2-billion-share total.

The significance of another big down day after last week's rebound effort shouldn't be underestimated.

Heading into Tuesday's session, the technicians at Lowry's Reports, the nation's oldest technical research firm, generally viewed the recent selling as a correction within an ongoing bull market, rather than the start of a new bear market.

"If we have another 90% downside day, that would change our attitude," Richard Dickson, senior market strategist at Lowry's, told me Tuesday afternoon. "If that happens, we'd have to re-evaluate that the lows were made a week ago, and we could be in for a lower low, perhaps substantially."

For the record, Lowry's defines a 90% downside day as a session in which both volume and price action are at least 90% to the downside. At press time, I am unable to confirm whether NYSE price action was also 90% to the downside; Dickson was unable to comment after the close.

And recent lows for major averages were 12,039 for the Dow, 1374 for the S&P and 2340 for the Comp.

"Everyone is going to key off the 1374 area" for the S&P, says a trader, who suggested that the upcoming expiration of stock index futures, stock index options, stock options and single stock futures probably exacerbated Tuesday's weakness. But Friday's so-called quadruple witching session "should settle out the market" in the days ahead, he adds.

"Tomorrow at the open we'll probably test that 1375 [level] and then get a snapback," says the trader. "But if it breaks 1375, I'm gone. I'll buy a dip here, but if it doesn't act well, 'See you later.' That's what everyone is doing."

The source, who requested anonymity, says the selling in the financials has been overdone and believes Lehman Brothers' (LEH Quote) first-quarter results will be the key to Wednesday's response to Tuesday's thrashing.

The broker "has said publicly they're totally hedged in subprime," he says. "If they get the Street to believe that, [the rebound] could be nice. The world hasn't changed that much."

And if I can get the folks at Carnegie Hall to believe I can sing...

Speaking of the financials: Concerns about a spreading of the so-called subprime fungus weighed heavily on names exposed to the sector, including Lehman, Washington Mutual (WM Quote), JPMorgan Chase (JPM Quote) and Bear Stearns (BSC Quote), which fell between 4.4% and 6.65%.

Even Goldman Sachs closed down 1.8% to $199.03, after trading as high as $208.56 intraday. The Amex Broker/Dealer Index lost 4.4%, and the Philadelphia Stock Exchange/KBW Bank Index shed 3.3%.

"Today Goldman reported good numbers and the stock is off $10 from its [intraday] high," says one market watcher. "That's not a very good sign short-term and says the corrective phase isn't over."

The source, who requested anonymity because of his firm's compliance requirements, also says the chart of the UltraShort QQQ (QID Quote) suggests more weakness ahead.

"I don't see how the market is making a low if [QID] is ready to rally," he says. "If we were at a bottom, QID would be topping. It doesn't look like it."

The QID, which returns twice the opposite performance of the Nasdaq 100, rose 4% on Tuesday.

Speaking of tech stocks: Lost in the subprime shuffle was the market's dour reaction to Texas Instruments' (TXN Quote) midquarter update late Monday. For the sin of merely narrowing its EPS and revenue guidance ranges, rather than raising the upper end, Texas saw its shares punished to the tune of 2.6%. Separately, Marvell Technology (MRVL Quote) shed 5.4% after a UBS downgrade, and the Philadelphia Stock Exchange Semiconductor Index lost 1.7%.

Notably, it was just Friday that the chip stocks were notably strong even as the broader market was flat. In this regard, Friday reminded me of the action on Feb. 22, as I noted on Saturday.

In hindsight, both Friday's session and Feb. 22 were harbingers of big declines. The lesson being: The chips are no longer leaders and may actually be a contrary indicator. For certain, be wary if the chips show strength in a vacuum.