Commentary: If the market thinks it will happen, it likely will
Fri Jul 11, 2008 5:18pm EDTPost (Tomi Kilgore is managing editor, TFN - North America, a Thomson Reuters market news service. The opinions expressed here are his own.)
By Tomi Kilgore
NEW YORK (Reuters.com) -- Say what you want about the irrationality of financial markets, but by virtue of their sheer size, what they believe does matter.
If the mass market thinks something will happen, fundamentals can be bullied into fulfilling their prophecy. Remember what happened to Bear Stearns.
Mortgage funding providers Freddie Mac and Fannie Mae, which in investors' minds provide the link between the housing crisis and the credit crisis, have been under pressure for some time.
The stocks took a dramatic turn for the worse this week on fears they might run short on capital but on Thursday, the Office of Federal Housing Enterprise Oversight tried to soothe investor fears, saying both Fannie Mae and Freddie Mac were "adequately capitalized," with capital "well in excess" of requirements.
On Friday, Sen. Christopher Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, declared "there's is no reason for the kind of (stock market) reaction we're getting." (For more, click here )
Trouble is, capital is only as adequate as the market believes it is. At Friday's intraday lows, Freddie had plunged 73 percent and Fannie had tumbled 64 percent in a week.
It's natural for some to think that such a vicious sell-off has an element of capitulation, the Wall Street buzzword for the bell that rings at the bottom.
A sharp midday recovery in the stocks, amid speculation that Freddie and Fannie would be given access to the Federal Reserve's discount window may have enticed some investors to bet on a bottom.
It's worked before; the Fed this year opened up the discount window for investment banks.
Lehman Bros.'s stock tumbled to multi-year lows on March 17 and then bounced sharply on similar news. The stock stabilized for a while, yet then it fell again and was last trading at the lowest prices seen since October 1999.
Investors buy stocks to make money, so until a stock can show the ability to take out resistance levels and make new highs, rather than just stabilize, sellers will return.
Sometimes a stock gets cheap for a good reason. The Japanese like to say: Yasukarou, warukarou (translated as the cheaper something is, the worse it is).
TURNING TO TECHNICALS
Let's take a look at those key resistance levels for the two mortgage agencies: The first resistance level to keep an eye on for Freddie Mac is the gap in the charts between Thursday's high of $8.99 and Wednesday's low of $9.88. For Fannie Mae, it's the gap between Thursday's high of $15.06 and Wednesday's low of $15.13.
That might seem like worthwhile upside potential from current levels, but just getting there isn't enough. As a rule, investors are likely to maintain a sell-on-rally stance until those resistance levels are first surpassed, then prove they can provide support.
For Freddie's stock, levels of any technical importance to the downside is first Friday's low of $3.89, then the all-time low of $2.53 hit in October 1990.
The downside levels to watch for Fannie are the August 1990 low of $6.22, followed by $4.40, which was the highest point of a 1 1/2-year trading range that preceded the January 1998 breakout.
Data that is nearly 20 years old may seem too anachronistic to be support, but they can provide a reference point amid the chaos. The alternative is to say that the only true support is zero.
