Vince Farrell of Scotsman Capital

From: vince farrell
Sent: Wednesday, February 27, 2008 12:49 PM

More bad news today (so of course the market is up.) The durable goods report was bad at -5.3%, but this number is notoriously volatile and keep it in that context. The new home sales report was abysmal falling to a level not seen since February of 1995, and Fannie Mae reported a worse than expected quarter. FNM is up at this moment which shows that bad news can be overly discounted in a stocks' price.

The WSJ reports that 2.2% of prime mortgages are at least 60 days past due up from 1.5% a year ago. More than 20% of sub-prime loans are at least that late. Since FMN doesn't deal in sub-prime, the higher loss at FNM shows the deteriorating levels of credit have spread into the prime arena. Moody's Economy.com figures that $1.75 trillion in mortgage debt is under water and the growing issue of "negative equity" will plague us for a while, especially if underwater homeowners choose to walk away.

While the Fed has cut rates 225 basis points and looks ready to do more as evidenced by Benanke's dovish House testimony today, mortgage rates have not moved down.The average interest rate on a 30 year fixed rate loan was 6.38% yesterday (WSJ), which is actually up from 5.61% in September. "Jumbo" loans, greater than $417,000, were a full point higher at 7.35%. It's obvious banks are unwilling to lend and will do so only under very favorable terms to themselves. Kind of negates the Fed's attempt to introduce some stimulus into the system. Applications for refinancings initially moved up when the Fed started cutting, but have since slowed markedly as banks have raised mortgage terms.

There is good news however. The best news is that stocks are going up in the face of unrelenting bad news. It could be a rally in a bear market, but I think we have seen the lows for the year and, while corrections are always likely, indeed necessary, the current action is heartening. It will be necessary for any large volume decline to be short (if steep) and tp be met by a sudden buying surge as buyers move in.

There is also a ton of cash on corporate balance sheets. Witness Microsoft's bid for Yahoo and yesterdays announcement that IBM has authorized another large share repurchase. Jason Trennert at Strategas notes that cash is at a high not seen in some time. Cash as a percent of total market capitalization is 11% for the S&P 500 (a total of %1.6 trillion!) It was 9% in 1995. Cash as a percent of market cap for the tech sector is a remarkable 24.7% vs 14.2% in 1995. Buybacks and special dividends are likely.

Speaking of IBM, the company raised its guidance yesterday to $8.25 to $8.35. The lower number would be an earnings gain of 16%. With the stock at $116, the P/E ratio on 2008 estimate is 14X. Fourteen times for 16% growth sounds ok to me. Th company reported free cash flow of $12.4 billion last year so the buback can be done with cash on hand ($16 billion) and free cash flow.

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