Sunday, March 15, 2009

What Is Next for the Doggie?

I indicated in my last Blog that I thought the market was not giving stocks fair value people could not separate the certificate of a share of common stock from the real company whose name is on the share of stock. I used as an example GE. At the time, I published that Blog the price of GE was around $7.00 a share. GE stock price ended this week at $9.62 or up about 38% for the week. Therefore, the question on everybody’s mind going into the weekend is, “how far or high can the markets go from the amazing week?”.

The short sellers want to figure out how high the markets will go so they can get back in before the market starts back down and test the most recent low of 6,500 in the Dow Jones and 672 on the S&P 500. I am taking a deep breath and I am going to predict that the Dow Jones could rise to about 8,500 and the S&P 500 could go as high as 900 before we go back and test the most recent lows. This is a 20% move from the current level to get to my target numbers for the markets.(No Guarantees)

Some of the things that could happen causing this move over the next 3 to 4 weeks are a change on the up-tick rule and a modification of the mark-to-market accounting rules. I have talked about the up-tick rule in the past. I have not discussed the mark-to-market accounting rules until now.

Let me start with the technical and then move to an example of what happens in mark-to-market accounting. The mark-to-market rule is an accounting rule that public companies, must adjust the value of an asset based on the sale price of a similar asset by another business. This is an over simplification of the rule. If the asset does not have a market, a place were the asset can be bought or sold, then the owner of the asset has to try as best they can to access the value of the asset. In many cases, because some markets are not functioning, it has been difficult to figure out the price of the asset like sub-prime mortgages.

Let me try to use a couple of examples to help you understand this issue. Let us say that your neighbor has to sell his house. He or she has lost their job and they need to cut their expenses. If they miss house payments then the mortgage will have to go to foreclosure and they will loose everything. They talk to a Realtor to try and figure out what is the price at which they can sell their house quickly. Let us also say that the normal market for the house is $300,000, they decide to put the house on the market for $250,000.

Now you have the same house in as good or better shape as the one that just went on the market for $250,000. If we were to apply the current mark-to-market rules, you would have to value your house at $250,000 on your financial statement. If the house were to sell for $200,000 then you would have to value your house at $200,000. Your house might be worth $300,000 in a normal market, but things today are not normal and your house is worth $200,000.

You have heard about all the sub-prime mortgages and that people are not paying these mortgages, houses are being foreclosed on, and as a result, other real estate is considered to have lower values. Here is the point, just because one mortgage is in foreclosure does not mean that all mortgages are in foreclosure. If you are making your mortgage payments and do not have any intention of selling your home, then why should the bank have to lower the value of your mortgage?

The major banks do admit that they have mortgage loans that are not performing (paying their payments). They contend and to a great extent I agree, if people are making their payments on time then the loan is performing and in turn is worth more than a loan where the borrower is not making the payments. If you were in the market to buy a mortgage investment wouldn't you rather own one that was making the payments vs. one that was not making the payments?

The House of Representatives Finance Committee is looking into these mark-to-market rules and the committee members are on record that they want the regulatory agencies to modify the rules for the unusual times we are in now. I believe the rules will be modified on mark-to-market accounting and that will spur the market to the levels I predicted. Only time will tell if I am right. Keep in mind that I think we will, have to go back and test the previous lows. I think the catalyst for that retest will be the auto companies and finding out if, we have the will to bail them out.

Dan Perkins

No comments: