The "kitchen sink" theory is out the window. There's a trust problem developing on the Street. Remember a few weeks ago traders drove up the stocks of companies like Citigroup , even though they did take very large losses for subprime and CDOs? The theory was that banks and brokers were "throwing in the kitchen sink" by taking conservative losses, that Q4 could start relatively fresh.
But Merrill has blown a big hole in that theory but taking a writeownthat is over $3 billion more than the $4.5 billion in losses they announced only three weeks ago. The Street no longer believes that the issues can be resolved in this quarter. One trader wrote to me, "Net net, its credit crunch part two, and it culminated today, and last time the street bought it, this time, obviously, there is no trust."
Another trader said, "the real question becomes 'what is the true value of book?'... Valuation is in question as liquidation value is unknown due to illiquid assets."
With that said, S&P had some surprisingly positive comments about Merrill a few minutes ago. Yes, they did cut their credit rating, yes, they used words like "staggering" to describe the $7.9 b writedown, and yes they highlighted their heightened concern over risk management and the company's business strategy (ouch!)
But further down in the press release there were comments that the overall business franchise was "solid"; that it's likely their performance will "recover significantly" in the current quarter.
Traders are in no mood to hear such comments. No trust. Merrill down 5%, Lehman & Morgan and Bear Stearns down about 3%.
All this is hurting earnings estimates. Fourth quarter earnings estimates are currently at a 10.0% increase for the S&P 500 (estimates from Thomson). It was over 11% just a week ago, and it's easy to see where the problems are: financials and consumer discretionary stocks.
Analysts now predict financial stocks as a whole will record an increase of only 3.0% in profits in the fourth quarter; at the beginning of the month the estimate was 7.0%. The problem? Analysts are bringing down estimates for the big guys--Citi, Bank of America ,Washington Mutual , Merrill. I believe this estimate will go negative soon.
In consumer discretionary (retail, autos, home builders), the same problem: increase of 19% now, was 22% a couple weeks ago, as analysts bring down estimates for General Motors , Ford ,Centex , and Pulte ; given what we are hearing from retailers, those numbers will come down in the next few weeks as well.
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