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I have been on Wall Street for fifteen years, and fully appreciate how the market will read the "purchase" of Bear Stearns for $2 per share is anybody's guess. As a manager of risk, I see the following:

• It is obvious Bear Stearns was bankrupt and could not have continued as a viable entity.

• Rather than have them declare bankruptcy, the Fed engineered a plan to have JP Morgan "buy" Bear Sterns for $2 per share. A price of $2 per share means the market was too optimistic in the last 14 months when Bear's stock fell from $169.33 in January 2007 to $30 per share as of Friday's close.

• $2 per share is about 1/40th of Bear Stearn's share price of a month ago (source: Bloomberg) JPMorgan's acquisition of Bear Stearns represents roughly 1 percent of what the investment bank was worth just 16 days ago. It marked a 93.3 percent discount to Bear Stearns' market capitalization as of Friday, and roughly a 98.8 percent discount to its book value as of Feb. 29 (source AP). A price of $2 per share tells you the market greatly underestimated the risk associated with holding leveraged securities backed by mortgages.

• Unfortunately, Bear Stearns is not the only firm to hold large quantities of leveraged securities backed by mortgages.

• Therefore, the market may be greatly overestimating the value of several other firms that hold these leveraged bets backed by questionable collateral.

• Bloomberg reported the $240 million "paid" for Bear is about 1/4 the value of Bear's headquarters in Manhattan. Said another way, Bear's headquarters building, which was included in the sale, is worth four times what JP Morgan paid for the entire firm. That means Bear, as an ongoing entity, was a liability as of Sunday. This is not surprising considering the rush for the exits by customers in the last few weeks and the loss-ridden portfolio of securities on Bear's books. Add the possibility of lawsuits against Bear's actions, and JP Morgan in effect said Bear is a liability in its present form, we will not buy it, but we will take it for $2 per share to help shore up confidence since the Fed has asked us nicely.

• If Bear Sterns went from having a $169 stock in January of 2007 to being virtually worthless today, it makes you wonder what other firms may follow a similar path to insolvency.

Some Technical Levels to Watch

Editor's Note: The text below was written before the announcement of the Bear Stearns sale for $2 per share.

Technical analysis employs charts and indicators in an attempt to understand market trends. Fundamental analysis is the “story” of what’s happening with the economy, a stock, or market sector. Technically, the global stock markets appear to be trying their best to form some type of bottom near current levels. If the January lows are not significantly breached, technicians will view this circumstance as an intermediate positive for stocks. If these lows do not hold, it will strengthen the secular bearish case.

Graph 2: S&P 500 as of close March 14, 2008

Graph 3: Dow Transports as of close March 14, 2008

Confidence increases in an environment where the fundamentals (the “story”) align with the technicals (the charts). For several reasons, including the widespread unwinding of leveraged positions, the fundamental news is not expected to improve anytime soon. However, a technical intermediate rally is possible from current levels. With plenty of cash waiting to move off the sidelines, even a technical rally could be quite powerful. At the moment the fundamentals and technicals favor more pain ahead for investors. The technicals are trying hard to make at least an intermediate turn.

The purpose of technical analysis is to understand what has happened and what is happening. To be a good technician, you need to keep an open mind and have the ability to put your personal fundamental biases aside. Heading in to Monday’s open, a good technician should see negative trends in stocks, which are attempting to form a bottom.

Time will tell.

Chris Ciovacco
Ciovacco Capital Management

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Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com

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