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Lehman Brothers is effectively on life support this evening after talks broke down on arrangements to liquidate its assets and/or find some partner willing to invest. Both Barclays PLC and Bank of America were rumored to be interested in some sort of arrangement however the sticking point was the desire by both firms to have a guarantee by the Federal Reserve or Treasury Department that their losses from the more toxic parts of the balance sheet would be covered. This guarantee would amount to the same treatment that JP Morgan received when it agreed to takeover Bear Stearns earlier this year.

Since that time, the Federal Reserve has actively lent money to these large institutions, both banks and brokerages, and taken their mortgage backed securities (MBS) as collateral in an attempt to provide much needed liquidity to a market where no investors were willing to take on the risk of toxic MBS paper. Now having amassed quite a large volume of paper of very dubious quality in an exchange for solidly-backed Treasury bills, there is a great deal of reluctance by the Fed to continue to support these Wall Street wizards.

In an interesting development, the International Swaps and Derivatives Association was meeting today as well in an attempt to settle trades that may be required under a Lehman collapse. If bankruptcy is declared before midnight, the trades are considered good and if not, then all trades arranged this afternoon are null and void.

The situation overnight continues to be remarkably fluid with an announcement that Bank of America will takeover Merrill Lynch for $44 billion, a sizable premium (some might call this an outrageous premium at 69%) over Friday’s closing price. Unwilling to share the same fate as Lehman, Merrill has evidently thrown in the towel. Judging simply by their share price, the sudden drop late in the week was indicative that once Lehman was history, Merrill would be thrust into the eye of the storm. That leaves just two independent investment firms, Morgan Stanley and Goldman Sachs. These two firms will be increasingly under pressure as they depend on short and medium term money markets to ensure funding for their operations unlike the large banks such as Bank of America to give one example. These large deposit-taking institutions have that funding base (deposits) to depend on and require less outside financing. One factor in favor of GS and MS is that they are less exposed to the mortgage morass than the other firms now departed or departing.

Ironically, all of this action overshadows another problem company, AIG, the largest insurer in the US. They are expected to announce the sale of several assets on Monday in a bid to raise capital as they contend with a likely downgrade by the Standard and Poor’s rating agency. Even once the assets are sold, the company will likely need to raise an additional $10 billion in capital. The insurance company has been hammered by its guarantees that it sold on MBS, which have been written down as a result of the ongoing mortgage crisis.

Finally, the Fed has released a statement that in order to ensure liquidity in the market from Monday morning onward, they are expanding their various lending facilities and widening the acceptable collateral.

The conclusion that one should draw from all this is that despite what government officials and company officers have said in the past, the crisis is not even close to over and they have no real handle on the situation preferring to patch holes wherever a leak appears. Fear and uncertainty is rising and this is never bullish for stock markets.

Technically Speaking

Last Monday’s rebound was sufficiently strong to drive momentum higher in the ensuing four days for all major markets and this was accomplished in spite of the bearishness of Tuesday’s fall. Both the broader markets and the tech sector managed weekly gains on heavier volume, which technically would suggest a continuation of the bullish move for the coming week.

Nevertheless, the financial wreckage this weekend will trump everything as the overnight futures are pricing in a 40-point drop on the S&P 500 at the current time. Such a fall in value would put the S&P 500 near 1210 and within throwing distance of its July low of 1200. If the Dow Jones Industrials slides to 11,000 as a consequence of the anticipated selling, then this benchmark would also threaten to mark a new low probably marking the beginning of a new leg downward.

The tech sector is not resistant to the onslaught either as overnight future prices suggest that the Nasdaq-100 could open more than 47 points lower putting it within a few points of its March low representing the 2008 low. In the case of the Nasdaq Composite index, touching down at the 2200 level is especially bearish as this would be the third time after March and July earlier this year. A third time reaching a low is usually a bearish signal warning of a breakdown through the low and the commencement of a new leg downward.

New Buy Recommendations (in order of preference):

None.

New Short Sales

Goldman Sachs (GS)

Morgan Stanley (MS) – These two brokerages are likely to be under steady pressure on Monday, which may make shorting them a particularly difficult endeavor. There is a likelihood that without further announcements benefiting their financial situations, they would gap lower to begin trading so one should consider a strategy of selling above the opening price after the initial wave of trades has been executed approximately one to two hours after markets open. (If there is little or no gap, trades should be executed at the open as normally recommended).

Stock Positions to Sell/Exit:

We were exited from all of our longs save for Sunoco.

Portfolio Comments:

New stops have been added in bold to the list while others have been modified. Those that have blanks are being carried unstopped for now. Please see our complete list of stops in the table below.

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

N.B. There are no longer restrictions on foreign stocks held in Canadian retirement savings accounts.

New stops in BOLD

* Stop on a closing basis

** Buy if above entry price

*** Split-adjusted price