Small caps poised to set wider losses into last trading hour

Jennifer Schonberger | Oct 10, 2008 2:34pm EDT | Comment

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Small caps continue to gyrate as realities and consequences of the financial crisis continue to grip traders. At 2:30 p.m. ET the Russell 2000 (NYSE:IWM) continued its slide, giving up 5%, or 25 points, to 474.14.

“I’m concerned that players are going to have worries over whether or not they’re going to be closing global stock markets on Monday,” said Andy Busch, global foreign exchange strategist for BMO Capital Markets. “Even though the U.S. has typically said that they’re not going to interfere and I don’t expect the U.S. to do it, there may be some selling right now as we get into the close over that. Indonesia closed their stock markets today for a third day in a row.”

Busch also said that losses from the Lehman’s CDS swaps have further exacerbated the credit crunch as financial entities are attempting to increase capital and pay for those losses. “So as the credit markets remain frozen, going into the close I imagine it will be pretty soft. I’m not sure if we’ll see 400 points like we saw yesterday, but the potential is there for it.”

President Bush addressed the nation this morning in an effort to calm markets, saying “we can solve this crisis and we will.” He said the government’s plans should work to shore up the financial system, but that it would take time to be implemented and for the effects to become visible.

The administration is weighing whether to guarantee bank debt and temporarily insure all U.S. bank deposits. Lending between banks remains frozen, with rates moving higher despite global rate cuts this week. Until these clogged credit lines open up, it will be difficult for the stock market to embrace a recovery frame of mind.

“They continue to throw everything in the kitchen sink at this until they can get the gears of the capital markets to connect,” said Busch. “We need to see the TED spread come in and we need to see Libor-OIS spreads come in. Basically what we’re looking for are people willing to lend their money longer than overnight and for collateral other than treasuries and none of those things have happened. Those are the key indicators.”

The G7 meeting will take place this weekend, as countries around the world attempt to make a coordinated effort to ease the global credit crunch and its reverberations through equity markets. On the table for discussion is a proposed plan by the U.K., originally reported by the Wall Street Journal this morning, in which Britain’s government would guarantee up to $432 billion in bank debt maturing up to 36 months. The G7 is supposed to discuss applying this plan in countries around the globe to shore up the domino affects of the credit crisis, which have caused global equity markets to free fall, banks to shutter and companies and consumers to struggle.

According to Busch another plan making the rounds calls for the use of custodian holdings of U.S. Treasury securities at the U.S. Federal Reserve. There are roughly $2.5 trillion of custody holdings currently of which $1.5 trillion are in Treasuries and $1 in agency bonds, according to Busch. These securities are only to be loaned out if given permission by foreign governments. Under the possible plan, the Fed would loan these securities to banks in exchange for taking on less in the way of securities such as commercial paper or mortgage backed securities. “This has the added benefit of circumventing any need to raise the statutory debt limit and would only cost if the lesser instruments default,” he says.

Oil has sunk $8.63 a barrel to $77 late afternoon, pummeled by expectations that global recession threatens demand for the commodity. The dollar is mixed against the euro and the yen. Gold is off $43 to $843 per troy ounce. Treasuries are actually down, as prices are down and yields are up. The yield on the 2-year rose to 1.63%, while the yield on the 10-year rose to 3.88%.

Negative news surrounding the financial sector continues to pour in. Moody’s capped a negative outlook on Goldman Sach’s long-term debt rating, pushing to stock to a fresh 52 week low.

In the latest meeting to sort out the credit crisis, the Federal Reserve met with counter parties of Lehman Brothers involved in the credit default swaps market with the bank to sort out existing damage within the market. Lehman’s collapse continues to be felt throughout the market. “The sound waves from the nuclear explosion of their bankruptcy are permeating the markets still and you have to spend a lot of time trying to figure out what’s happened legally and how it’s going to play out. It’s a huge loss of money and it certainly exacerbated the credit crunch.”