March 17, 2008

Market Comments for March 17, 2008

1) Bear Stearns (BSC) was taken over by JP Morgan (JPM) at $2/share, about 5% of its breakup value of $7.7 billion. It is a virtual total wipe out for the BSC equity holders. JP Morgan stock jumped 10% on the windfall gain. They are getting about $20 billion of sub prime securities for free in the deal. The HQ building alone is worth $4 billion. Half of 14,000 employees will lose their jobs. Clients were pulling out money on Friday as fast as they could write the wire transfer orders. Some people knew this was coming. On Tuesday when the stock was still above $60, more than 90,000 $35 strike BSC puts were bought at 20 cents. They hit $33 today with an implied volatility of 700%, a gain of 165 times! The other big winners in the deal are Bear Stearns bond holders which now have a de facto JP Morgan guarantee. Next to be targeted by short sellers: Lehman Brothers, which has dropped 50% since Friday. It reports earnings on Tuesday which could spark a further sell off.

2) Crude dropped $7 on the Bear news for fear of margin calls on all other speculative products. All other commodities except gold also suffered big drops. Hedge funds are selling their good positions to meet margin calls on the bad.

3) The futures market is now discounting a high probability of a 100 basis point cut by the Fed tomorrow. Anything less than that and there could be another market sell off.

4) There has been a wholesale stampede into risk free assets. The 90 T-Bill rate got as low at 80 bp today, which is as low as it has been in Japan. The ten year bill hit 3.30%. After tomorrow the US dollar may become the new carry currency, replacing the yen. There are massive unwinds of short yen, long euro positions going on.

THOUGHT OF THE DAY

30 year Treasury bond futures hit 122 today, yielding 4.2%, the highest price since the big deflation scare of 2002. In the meantime the yield on Treasury Inflation Protected Securities (TIPS) are now trading at negative yields, indicating a strong resurgence of inflation by year end. This makes 30 year bond futures a screaming short, with my three year target at 85. Do this five times, a relatively low amount of leverage in the bond market, and you will get a three year return of 150%.

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