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Stocks tore higher Monday as U.S. and European policymakers finally appeared to have coordinated on fighting the credit crunch with tanks and cruise missiles rather than bayonets and hand grenades.
Realizing that investors were properly scared out of their wits by the lack of cooperation among governments in an era of intense globalization, U.S. and British finance officials have abandoned half-baked plans to buy bad banks' lousy mortgages at a premium and instead are attacking the problem of solvency and confidence by directly injecting capital into good banks to immunize them against future potential losses and by proposing a blanket guarantee of all deposits, period.
The Dow Jones Industrial Average ($INDU) soared more than 900 points Monday. Volume on the New York Stock Exchange tracked around 10-1 positive -- meaning more than 90% of trades were buying shares at a higher price -- as investors recognized this was a very important step forward.
The session constituted the sort of "90% upside day" that I suggested in this July 24 column would signal at least an intermediate end to the 2008 slide.
And signal that it's time to get back into the market, at least for a while. More on that in a moment. First, to the rescue.
Enthusiasm around a plan
The Irish government first came up with the blanket bank deposit guarantee idea two weeks ago, and its genius was obvious: By simply stating that they are backing all deposits, governments are likely never to have to actually do it. It attacks the issue of confidence where it matters most: giving banks the courage to lend to each other without fear that the other party won't pay the principal back with interest, and giving individuals the courage to move money back from Treasury bills and money market funds to banks, where it can be lent out to businesses that wish to expand and individuals who wish to finance homes, cars and college educations.Money in banks has a multiplier effect; money in Treasurys just sits in a corner like a dunce.
There are plenty of problems remaining in the credit markets, and economic growth will likely remain scarred for at least half a year by the brutal beating investors have taken in the past month. And investors have been badly burned over the past nine months by Treasury Department promises that have not panned out. But this is the first plan that does not ring hollow. The devil will be in the execution, but the simplicity of the concept, and the ease with which it can be implemented, are encouraging.
What's the difference? Well, about a week ago, in this column, I said that there was an opportunity for a 300-point increase in the S&P 500 Index ($INX) if the world's central banks would finally coordinate, as smart traders with cash would switch on a dime, so to speak, from fear of total world financial annihilation to fear of missing a major bear-market rally. And in this Oct. 3 column, I described why direct injection of capital into banks, not a loan bailout, was necessary. And the move we are seeing today is a reflection of confidence that these two necessary new actions are finally being taken.
Moreover, selling was so intense last week that it was almost inconceivable that there would not be a reaction in the opposite direction. At moments like this, I tell my newsletter subscribers to rely on Fibonacci analysis because it helps traders understand the potential for "retracements" of big moves.
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So bear with me here for some technical talk. Fibonacci math suggests that we should get at least a 50% retracement of the recent decline either from the 1,300 level held by the S&P 500 in late August or from the 1,200 level held in late September before the wheels fell off. In either case, you should theoretically get a rebound to the 1,020 to 1,075 areas, which would amount to robust 13% to 20% advances from Friday's close.
Looking simply at what companies are worth, by late Friday investors could see what appeared to be incredible values cropping up in companies involved in commodity production, steel, banking, global power infrastructure, tech and consumer products. Major global builders with big backlogs, such as KBR (KBR, news, msgs) and ABB (ABB, news, msgs) were trading for price-earnings multiples below 7, which is exceedingly low considering their growth prospects in regions that can definitely pay the bills.
Companies are typically considered undervalued when their P/E ratios are lower than their growth rates. If a company is expected to grow earnings 15% per year and its P/E is 10, then expectations are probably too low and the stock is likely undervalued. I'm seeing such situations across the market.
I can make the case for Cisco Systems (CSCO, news, msgs), with a P/E ratio on next year's earnings of 9; Google (GOOG, news, msgs), with a P/E of 15; hot teen-apparel brand Volcom (VLCM, news, msgs), with a PE of 8; teen-apparel stores Abercrombie & Fitch (ANF, news, msgs) and American Eagle (AEO, news, msgs), with P/Es under 7; and Freeport McMoRan Copper & Gold (FCX, news, msgs) and Southern Copper (PCU, news, msgs), with P/Es under 5 and rich dividends.
And the energy companies, my goodness, by the close Friday traders were beyond speechless looking at the values now in many of the most important companies in the world: Range Resources (RRC, news, msgs), XTO Energy (XTO, news, msgs), EOG Resources (EOG, news, msgs), Chesapeake Energy (CHK, news, msgs), Peabody Energy (BTU, news, msgs), BHP Billiton (BHP, news, msgs) and Vale (RIO, news, msgs). The term "dirt cheap" didn't do them justice.
Continued: Some words of caution
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