It ain't over 'til its over -- and it ain't over.Last week, the market rallied out of the abyss as it has on so many occasions over the past 12 months, as neither rain, snow nor structured finance seems capable of keeping Mr. Market in the doghouse -- and me off of the cold linoleum floor, drinking cheap tequila. Everybody, it seems, is getting fat in this market, except for Papa Kass. Later in this article: three reasons we're in for tough sledding. But first, was the financials' rally all it was cracked up to be? As recently as Thursday, I suggested that an oversold bounce could be in the offing in financials, and bounce they did after Microsoft's ( MSFT) stellar results that evening, speculation that Merrill Lynch's ( MER) Stanley O'Neal was about to be fired (which proved correct), after Countrywide Financial's ( CFC) "upbeat" forecast (which I don't believe for a minute), and probably on the basis of a growing view that the worst of the mortgage writedowns is behind for the financials. I suspect the short-term rally is not yet over in the money-center banks, as they are still quite oversold; that it is about over for brokerage stocks ( Barron's Jackie Doherty presented an excellent summary on the group over the weekend); and that some of the specialty finance companies, such as private mortgage insurers and mortgage originators, have already had most (if not all) of their "fun in the sun" during last week's dead-cat bounce.
- 1. The generally lower-trending yields in the bond market -- the yield on the 10-year U.S. note is under 4.30% -- seem to be foretelling an economic slowdown and, possibly, a sharp deceleration or contraction in corporate profits in 2008. And the continued ramp in the price of crude oil continues apace (up another dollar this morning) and will likely serve to dampen personal consumption expenditures and pressure corporate profit margins (as input costs increase) on the outset of a "winter of our discontent." 2. As a byproduct of the mortgage mess, the Financial Times and Challenger Gray & Christmas report that over 140,000 financial-services jobs have been lost in this down cycle. The protracted housing downturn will exacerbate the weakening job picture and points toward disappointing domestic economic growth in early 2008. 3. Even more important, my continued concerns regarding more subprime fallout are based on the substantive and hellacious price action of the ABX BBB- subprime and the AAA-rated mortgage indices -- the sector that much of the Merrill Lynch writedown encompassed -- which continued their schmeissing through Friday's close. For some perspective, the ABX BBB- Index now trades at around 20; it started the year above 95. More surprising, from both price depreciation and from the standpoint of being ignored by market participants, has been the decimation in the top-rated, credit-enhanced and well-protected ABX AAA Index, declining from around 95 to 85. As a result, I am confident that not only does Merrill Lynch have more writedowns to come in the current quarter but that a number of other financial institutions, such as American International Group ( AIG) and the money-center banks, have not faced up to the credit music. We shouldn't lose sight that September and October saw steady price degradation in mortgage product pricing, and I stand on my statement that AIG will report a writedown in excess of Merrill Lynch's $8 billion third-quarter 2007 loss, despite CNBC refuting the story.