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‘Irrational Exuberance’ of 1990s Unwound

November 21st, 2008
By JOE WINDISH, Technology Editor

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Aaron Task:

Any way you slice it, the 2008 is shaping up to annus horribilis for the U.S. stock market. Heading into Friday’s session, in which an early rally effort quickly faded, the S&P was down 49% year-to-date and on track for its worst year ever. Down 43% year to date, the Dow is heading for its second worst year in history, the WSJ reports, trailing only the 53% decline in 1931.

While the major averages tell a grim tale, the action in components of the S&P 500 speak to the extent of the devastation. Heading into Friday’s session:

  • 115 S&P stocks were trading under $10
  • 41 were trading under $5
  • 204 were trading with a market cap of less than $4 billion

These are not the only criteria used for inclusion in the index, but S&P 500 companies typically have market caps above $4 billion and stock prices above $5. Furthermore, many institutional fund managers are prohibited from owning stocks that trade below $10 or $5, depending on the firm.

In other words, a lot of companies currently in the S&P 500 may not be eligible for membership or, more importantly, ownership by major institutions. That, in turns, may mean more selling ahead, even though stocks are “cheap” based on a variety of metrics.



This entry was posted on Friday, November 21st, 2008 at 1:53 pm and is filed under Wall Street, Business. You can leave a response, or trackback from your own site.

Viewing 3 Comments

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    For a long time I wish the Dow were raised to 50 companies; then we've have indexes of 50, 500, and 5000 companies at hand.

    I believe there's no need to panic or swoon (much less engage in the hype I saw, for example, last night on CNN briefly). Overreaction is not justified, and besides, things are likely going to get worse before they improve. [shrug] The hypesters can elevate Obama into the ionosphere if there is a good recovery soon after he takes office next year.

    In the meantime, Citi has flirted with asset divestiture, Cerberus (Chrysler's parent) has admitted thinking already of bankruptcy, the UAW is muttering about reconsidering its bluff, and there will likely be painful reforms not only in Detroit and at Citi but with other banks* and insurance companies; the Bush administration is running out of time to pick favorites in the financial sector (it bailed out a company of Paulson's friends, but let Lehman Brothers fail, don't forget).


    * To this day I don't see why the Detroit Three or the UAW didn't redefine themselves as banks to try to get a prompt bailout from the financial bailout honey pot.
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    Pages through 97 (with some missing) are available and worth reviewing here.

    http://books.google.com/books?id=EUp2jo-3KQkC&p...

    Here's to an "interesting" 2009 when we've survived it. (Who, me, hype?)
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    "Furthermore, many institutional fund managers are prohibited from owning stocks that trade below $10 or $5, depending on the firm."

    That's absolutely correct. Though that doesn't mean that once a stock drops below a threshold amount that a major institution which has such a rule preventing ownership of stocks below a certain amount needs to immediately sell it. I think institutions generally have until the end of the fiscal quarter to make the decision.

    Many people buy stocks based on future performance (why buy a stock if it's going to perform poorly?), making this an important valuation metric. Even though some stocks by some metrics may currently appear cheap, many stocks which have already fallen are overvalued based on future earnings potential (relative to historical ratios).

    I don't mean to get into a debate about how one should evaluate stocks. I'm pointing out one aspect and one reason why stocks may continue to fall....

    So the combination of falling revenues and self-imposed prohibitions on institutions to earn stocks that don't meet a certain criteria will lead to further stock declines. I wouldn't be surprised if some institutions relaxed this policy given the unprecedented conditions we're in. Though that would more than likely open up shareholder lawsuits against those (investment) institutions....

    One last note.... when Citibank announced it was buying Wachovia Bank I made a comment that C was having its own problems (I think I said that C had "poor management") and I didn't understand how they could take on WB. As we know Wells Fargo snatched WB from C. Sure enough C has continuing problems and has lost some $250 Billion in market value since its high a year or two ago.... C wil continue to have problems with its stock price (now $3.60/share.... down from an approximate high of $55 a year or two ago) because nearly 2/3rds of the stock is owned by institutional investors who may be forced to sell in the next month or so because of C's threshold stock price (of $5 or $10/share) being breached.

    Some of C's counterparties (other financial institutions who do trades with them) are looking very closely at C and their performance. What will be most interesting is if C's clients (corporate or retail) start to flee.

    Personally I don't care much for C: I think they have (or had) lousy risk management and poor management in general. Having said that I think the position that C is in now is not entirely of its own making (like many other banks we've seen fail or merge) over the past year or so.... I think most of these problems are a lack of confidence in the bank and people (clients and investors) choosing to take their losses before the potentially worsen. This is just a vicious circle that forces these banks into failure (or the need to merge). don't get me wrong.... these banks did start down this path on their own. I just think the end result (failure or merger) is not justified. But that does create great opportunity for stronger and much better managed competitors.
 
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