While the Market appears to be trying to find a bottom, last week’s price action has resulted in conflicting indications from a technical perspective. During Thursday’s morning sell off, most Major Indexes saw their previous lows exceeded. This implies the down trend is still in place and suggests another leg down is possible. Later in the trading day, prices abruptly reversed resulting in a rally which took the DOW up 870 points from the day’s low.
Friday’s price action further clouded the indications when prices for the Dow Jones Industrial Average and the S&P 500 eclipsed the previous day’s high only to reverse in late day trading ending with a substantial loss at the closing bell.
Given the lack of clarity in the current Market conditions, the probable Market direction for the coming week is cannot be determined at this time.
Bob
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Monday, November 17, 2008
GM and the Stock Market
For the most part, I took the weekend off and didn’t finish my thoughts for last week’s Market Update. It is now Monday morning, before the “Open”, here are some additional considerations.
The Market has been faced with a never ending sea of bad news each time it attempts to stage a rally. Perhaps the most pressing issue for this week and next involve the Auto Industry. GM claims to be out of money and will have to seek bankruptcy protection before the end of the year. Under “normal” financial conditions, a corporation under the control of the bankruptcy court would secure “Debtor in Possession” (DIP) financing from private sources and continue operating while attempting to restructure into a viable entity. In today’s environment, private DIP financing is not available. This has lead GM to approach the government for assistance.
When major corporations have filed Chapter 11 in the past, the usual outcome has been as follows.
The owners of the corporation (shareholders) usually lose their investment, if and when the outstanding stock is canceled. This action allows the corporation to obtain new capital through the issuance of new stock. The logic behind this segment of the bankruptcy process is this, the shareholders, as owners, have the responsibility to insure the board of directors they have elected are managing the company responsibly. If this is not taking place, the shareholders have the right and responsibility to replace them or suffer the consequences.
The corporate bond holders are individuals and institutions which have lent money to the corporation in exchange for the promise of higher returns on their capital then they would receive from Government issued debt. For these higher returns, the bond holder agrees to accept the risk that some of their capital may be subject to loss. Under the supervision of the bankruptcy court the bond holders and the corporation will negotiate new terms for all lenders. The outcome of past negotiations of this nature has resulted in substantial loss of capital for the bond holder.
Vendors which have accounts receivable payable by the bankrupt company may see these receivables converted to “claims” in the court system. There have been previous situations where the vendors have received very little on these claims.
Employees both past and present inevitably see reductions in pay and benefits from the bankruptcy process.
The theoretical goal and purpose of Chapter 11 of the Bankruptcy Code is to allow a company to restructure its capitalization, debt and labor cost so that it is able to compete in the current economic environment. Thus preserving jobs and providing economic stability to affected communities.
GM’s immediate future has far reaching implications on the Financial Markets. This leads to the dilemma being faced on Capitol Hill this week.
If the government denies GM’s request completely, the company would be forced to seek private DIP financing which may not be available. This could force GM into Chapter 7 bankruptcy resulting in the liquidation of their assets. One outcome of this would be the loss of well over three hundred thousand jobs when supporting industries are taken into consideration. This would almost certainly cause the already fragile Financial Markets to continue their precipitous fall.
If the government provides GM with a bailout loan, business will most likely “continue as usual”. Nothing will have changed, the board of directors will remain in place, the debt and capitalization structure will remain unaltered and labor costs will remain at their current levels. In effect, GM will continue to be at a competitive disadvantage in the world market. The Financial Markets may initially view this option positively, favoring the short term fix.
A less talked about option is for the government to grant DIP financing to GM which would provide the liquidity required to navigate the Chapter 11 bankruptcy process. While this may be the best long term solution to GM’s systemic problems, the process is slow and tedious. The Financial Markets have become very impatient and may not look upon this approach favorably.
Washington’s decision on GM’s fate could quite easily start the Stock Market moving. The direction however remains in the balance.
Bob
The Market has been faced with a never ending sea of bad news each time it attempts to stage a rally. Perhaps the most pressing issue for this week and next involve the Auto Industry. GM claims to be out of money and will have to seek bankruptcy protection before the end of the year. Under “normal” financial conditions, a corporation under the control of the bankruptcy court would secure “Debtor in Possession” (DIP) financing from private sources and continue operating while attempting to restructure into a viable entity. In today’s environment, private DIP financing is not available. This has lead GM to approach the government for assistance.
When major corporations have filed Chapter 11 in the past, the usual outcome has been as follows.
The owners of the corporation (shareholders) usually lose their investment, if and when the outstanding stock is canceled. This action allows the corporation to obtain new capital through the issuance of new stock. The logic behind this segment of the bankruptcy process is this, the shareholders, as owners, have the responsibility to insure the board of directors they have elected are managing the company responsibly. If this is not taking place, the shareholders have the right and responsibility to replace them or suffer the consequences.
The corporate bond holders are individuals and institutions which have lent money to the corporation in exchange for the promise of higher returns on their capital then they would receive from Government issued debt. For these higher returns, the bond holder agrees to accept the risk that some of their capital may be subject to loss. Under the supervision of the bankruptcy court the bond holders and the corporation will negotiate new terms for all lenders. The outcome of past negotiations of this nature has resulted in substantial loss of capital for the bond holder.
Vendors which have accounts receivable payable by the bankrupt company may see these receivables converted to “claims” in the court system. There have been previous situations where the vendors have received very little on these claims.
Employees both past and present inevitably see reductions in pay and benefits from the bankruptcy process.
The theoretical goal and purpose of Chapter 11 of the Bankruptcy Code is to allow a company to restructure its capitalization, debt and labor cost so that it is able to compete in the current economic environment. Thus preserving jobs and providing economic stability to affected communities.
GM’s immediate future has far reaching implications on the Financial Markets. This leads to the dilemma being faced on Capitol Hill this week.
If the government denies GM’s request completely, the company would be forced to seek private DIP financing which may not be available. This could force GM into Chapter 7 bankruptcy resulting in the liquidation of their assets. One outcome of this would be the loss of well over three hundred thousand jobs when supporting industries are taken into consideration. This would almost certainly cause the already fragile Financial Markets to continue their precipitous fall.
If the government provides GM with a bailout loan, business will most likely “continue as usual”. Nothing will have changed, the board of directors will remain in place, the debt and capitalization structure will remain unaltered and labor costs will remain at their current levels. In effect, GM will continue to be at a competitive disadvantage in the world market. The Financial Markets may initially view this option positively, favoring the short term fix.
A less talked about option is for the government to grant DIP financing to GM which would provide the liquidity required to navigate the Chapter 11 bankruptcy process. While this may be the best long term solution to GM’s systemic problems, the process is slow and tedious. The Financial Markets have become very impatient and may not look upon this approach favorably.
Washington’s decision on GM’s fate could quite easily start the Stock Market moving. The direction however remains in the balance.
Bob
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