Unprecedented Stock Market Volatility, Unpredictable Future

With US financial stocks falling nearly 12% on Monday despite the short selling ban, it is clear that last the week before last’s euphoria was mostly a bailout rally, not a simply a short squeeze as many would like to believe. Much of last week’s movements were dependent on the relative progress of the US Government bailout package. A large part of the ‘freaky’ Friday’s optimism subsided, as investors sat back and examined the proposals and the impact of last week’s frenzy with a clearer head. As expected, Bernanke, Paulson, and Bush are not having an easy ride in their bid for congress to approve the $700 billion bailout plan. Despite Bush’s dramatic claims of an impending financial collapse if the bill isn’t ratified, politicians will not find it an easy sell it to their voters, especially in an election year with 55% of the US public opposed to the plan. It is not hard to see why, with extraordinary clauses such as a request for no judicial or administrative reviews of the spending in this bailout. In the end the key issue may not be whether the US government can afford it, but whether it can afford not to do it.

It wasn’t all bad news for financials, with traders buoyed by the news of Warren Buffet’s investment in Goldman Sachs. However, traders were cautious as to what this deal signified. Some believe it to be a vote of confidence in Goldman’s by Buffet, while other see it as a Buffet picking up a great return at bargain basement prices. In the UK financial stocks underperformed as Libor spiked to the highest levels since January. Despite the dramatic interventions over the past two weeks, traders have remained firmly sceptical about general exposure to toxic subprime debt.

Many are expecting a ‘bailout rally’ when the Bush/ Paulson plan is finally passed similar to day when the idea was first mooted. While this may happen, the effect may be short lived. Once the subprime problem has been largely addressed, there is still the issue of banks being underfunded, and the even greater problem of a weakening global economy. The latter in particular seems to have been playing second fiddle to the problems specific to the credit markets.

More US regional banks are in trouble despite the planned bailout package. Regions Financial (Alabama’s biggest bank) and Marshall & Ilsley Corp (Wisconsin’s largest bank) all were well down on the week. Although at present not on the cards, a collapse of small US or international bank wouldn’t spark the collapse of the financial system as we know it, but it does lead to two gloomy thoughts. Firstly, the blanket ban on short selling financial stocks is not a panacea. In fact the last time short selling was banned in 1932, the Dow Jones made a small rally then rolled over by over 40%. Secondly, despite the bailouts and liquidity injections, we may not have seen the last financial institution across the world to fail. While it may not be another major firm, the result is still not going to be positive for market sentiment.

Next week’s flow of economic news is dominated by Wednesday’s ADP Non Farm employment change and Fridays Non Farm payroll figures. Other top tier announcements include Wednesday’s US ISM manufacturing PMI and UK Manufacturing PMI. Thursday brings UK Nationwide house price figures while the ECB press conference on Thursday could also move markets.

It is hard to predict what could happen next with so much dependent on the progress of the bail out package through parliament. If or when it is passed the resulting spurt could be short lived, perhaps leading to a more sustained bear market as the economy takes centre stage again. A Double Touch trade predicting the Dow Jones will touch 11500 and 10799 (in either order) at any time during the next 20 days could return 159% at betonmarkets.com.