This Post-Bailout Rally Will Be Short Lived

Now what?... $2,400 per hour... Six-year-old news tanks UAL shares... No deal for LEH... Street compensation intact... Have we been saved?...

Now that Fannie and Freddie have been effectively nationalized, you should be asking yourself a critical question, perhaps the most important question investors ever ask: Now what?

One important trend to watch out for is bank failures, hundreds of them, mostly small institutions, all across the country. I also believe another big one will fail, like Wachovia or WaMu for example.

One thing is for sure. Banks like these two are desperate to attract deposits. They're paying 5% and higher on a five-year CD, when Bankrate.com shows the average at around 3.59% today.

Bloomberg tells us the lawyers for former Enron investors will get about $688 million in legal fees for recovering approximately $7.2 billion from Enron's lenders, auditors, and directors.

The Enron lawyers worked 280,000 hours and made just over $2,400 an hour. They worked out settlements with Bank of America, Citigroup, JPMorgan Chase, Canadian Imperial Bank of Commerce, Lehman Brothers, Arthur Andersen, Kirkland & Ellis, and Enron's former outside directors, among others.

Porter sent a note along this morning about the Enron settlements, asking, "Why is it that in our culture if you commit a big enough crime and can afford to pay a big enough fine, it's as if you haven't done anything wrong?"

Good question. I don't know the answer, but I know the situation isn't unique to our culture or our time, as this Augustine quote demonstrates:

Elegant and excellent was that pirate's answer to the great Macedonian Alexander, who had taken him; the king asking him how he durst molest the seas so, he replied with a free spirit: "How darest thou molest the whole earth? But because I do it only with a little ship, I am called brigand: thou doing it with a great navy art called emperor."

– St. Augustine, City of God, Book IV, written about 1,600 years ago

Ok, from now on, no more telling us we're frauds... Yesterday, a financial newsletter published a six-year-old Chicago Tribune story on United Airline's 2002 bankruptcy as current news on the Bloomberg newswire. Shares immediately plummeted more than 75% and halted trading midday.

United said the reports were "completely untrue." Richard Lehmann, president of Income Securities Advisors, the distressed-debt newsletter's publisher, said his company found the article through a search on Google's news page. United shares opened yesterday around $12, fell to $3 on the false report, then closed at $10.92.

South Korea's Financial Services Commission Chairman Jun Kwang-woo said today that Korea Development Bank ended talks with Extreme Value short pick Lehman Brothers. KDB had been considering taking a stake in the U.S. investment bank. Jun declined to say if any conclusions had been reached... "There will be other opportunities," he said.

Lehman fell as much as 45% today. It might not be the bottom, but it feels very much like a moment of maximum pessimism... and therefore a great moment to exit a short position.

One of the major points David Einhorn raised when presenting his short thesis on Lehman was that Wall Street banks pay out 50% of gross revenues in compensation – an absurd amount. And even with the economy crumbling beneath it, Wall Street is still paying big numbers.

In a Monday report, financial industry analyst Meredith Whitney said revenues for Wall Street firms have declined 63% in the first half of the year, but compensation costs have only declined 24%. And noncompensation costs, like travel and entertainment, have actually risen 25%. The numbers lead Whitney to forecast far more layoffs for bankers.

European banks HSBC and Standard Chartered will be the first overseas banks to incorporate local operations in Vietnam. Today the State Bank of Vietnam awarded each bank a license to open wholly owned units in the country. Forty foreign banks account for less than 15% of total lending in Vietnam, and local incorporation will give HSBC and Standard Chartered a huge jump on the competition. The Asian country is still popular with overseas banks – only 10% of its population hold bank accounts.

Two notable institutional buys...

David Einhorn filed for 990,000 shares of Pomeroy IT Solutions, 8.3% of the company. Pomeroy is a $60 million IT outsourcing company with sales of $606 million and operating cash flow of $5 million.

Steve Cohen, of mega hedge fund SAC Capital, filed for 1.68 million shares, 7.4% of United Therapeutics. United is a $2.5 billion biotech company that develops treatments for life-threatening diseases.

New highs: Wal-Mart (WMT), Johnson & Johnson (JNJ).

If you're the lone Extreme Value reader who bought Wal-Mart (up 30%) AND shorted Lehman Brothers (down 80%), write to us at feedback@stansberryresearch.com.

"There ain't no secret to losing weight, regardless of what the diet salesmen out there will tell you: burn more calories than you consume. If you're fat, er heavy, it's not because you don't process carbs normally or because you have a slow metabolism, or because your gramma Matilda passed you some bad genes or because the American food machine conspired to feed you corn sweetener. It's because you eat too much and sit on your ass. Eat less and get off your ass. You'll weigh less and your body will feel better for it." – Paid-up subscriber Neil A. Bourjaily

Ferris comment: Sounds like a radical approach. Is there a book about it?

"I am a bike rider, and have the luxury of living in the country and working from a home office so I can ride at lunch during the week when there are few cars and the dogs are tied up. I wear a helmet, and did not appreciate it until one day...

"Riding along a country road I came over a small hill and there was an idiot with his 4-wheeler and trailer parked completely across my lane with a truck in the left lane. I tried to stop, was forced off onto the shoulder still moving. As I tried to get back on the pavement my wheel caught the edge of the asphalt and I went over sideways with feet still clipped onto the pedals. I still remember the 'crunch' sound as the side of my head hit the pavement. I got up, cursed the guy in the 4-wheeler out for being an idiot, and rode on. When I got home I took off my helmet and was amazed.

"The side was destroyed, cracked, busted up, with pieces of road gravel embedded in it! I was fine, no cuts, no bruises, no headache. If that had been my head that was busted open with the embedded gravel I would have been nearly dead. A helmet will not do anything if you are hit directly by the 4,000-pound SUV, but most bike accidents involve being run off the road, where a helmet is a BIG help. I'm a convert." – Paid-up subscriber Jon

Regards,

Dan Ferris

Medford, Oregon

September 9, 2008

This Post-Bailout Rally Will Be Short Lived

By Ian Davis

Hurray! The federal government has stepped in to save us... right?

On September 7, the Federal Housing Finance Agency (FHFA) seized control of Fannie Mae and Freddie Mac. Under their "conservatorship," the FHFA has ousted the companies' CEOs and done away with dividend payments.

The Treasury has also been authorized to purchase up to $100 billion in preferred stock from each of the companies and provide short-term funding to Fannie, Freddie, and 12 other federal home-loan banks.

This latest "rescue" marks the fourth time we've seen the federal government intervene in the stock market since July 2007...

On August 16, 2007, the Federal Reserve performed an "emergency" cut of the U.S. discount rate. Then, on January 22, 2008, the Federal Reserve cut its fed-funds rate in an unscheduled meeting. The government interfered again on March 16, 2008, by financing the takeover of Bear Stearns by JPMorgan Chase.

And each time the government stepped in, the stock market rallied – up between 6.5% and about 11%. But after these short-term rallies, the market has fallen to new lows. Take a look...

Previous Government Moves Have Led to Short-Lived Relief Rallies

As you can see, aside from the bounce after July 15, the government has been responsible for every relief rally we've had since last summer. (Collapsing oil prices sparked the July 15 rally.)

Here's what the three previous government-induced relief rallies looked like...

So we could expect a rally of 6%-11% in the coming weeks. But there is one difference between this rescue and the rest. Take a second look at the above chart...

In the past, the government has rescued the market from new lows. But the Fannie and Freddie bailout didn't come at a new low. If you measure the current relief rally from the July 15 low, we don't have very far to go before the peak.

The market was up 2.1% yesterday, but then it reversed its gain today... Right now, it's basically flat for the week. Point is, we're not out of the woods yet. This rally may be even shorter than the rest. These government interventions are only temporary...

Good investing,

Ian Davis

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