Wednesday, July 15, 2009

There and Back Again - 7 / 15 / 2009

Times like these give a new definition to the term trading range. Here, the past 2 weeks Dow Jones Index closing prices:

7/1 8542
7/2 8280
7/6 8324
7/7 8163
7/8 8178
7/9 8183
7/10 8146
7/13 8331
7/14 8349
7/15 8519 -> at 10:30am

That is a 500 point or 5% swing over 2 weeks. The Financial media loves to scream market up 100+, market down 100+. But this simple table shows the real story, traders control this market and game other traders up and down based upon questionable government financial statistics and surprise earnings or revenues from Fortune 100's.

Meanwhile instead of investigating the reasons why unemployment, housing starts, bank lending seems to improve month by month, while the previous month's numbers are revised down to worse than previously reported virtually every time, CNBC has decided to focus on the new genius at Goldman Sachs (Blankfien), the marijuana and porn industries. One day we may see Lloyd Blankfien and Jamie Dimon speaking at the CNBC Porn / Marijuana conference.

Seriously, these matters leave me wondering whether the investment markets will return. And contemplating the recent Dow Jones price action, my thought is, it has returned. Investors are the support in the market, traders are the noise. Shut out the noise and focus on the 6 month trend of your favorite issues.

Select them because they are trading at real, conservative, multiples to earnings or enterprise value, and also because they have enough cash (or short term securities) to fake their earnings if they need to. Yes I meant to say that. Don't kid yourself. The biggest, best companies manage their earnings, storing them on the balance sheets when the market dynamics won't give their stock price a decent multiple for their full value, and pulling them off the balance sheet and flowing them through the income statement when times are tough.

Earnings, even for the biggest companies are lumpy. Somehow, unless there is a crisis or a one time event, they are not lumpy. This makes virtually no sense unless the company is a utility. But still GE, DELL, AXP, MSFT, XON, they all have consistent, managed, growth or earnings.

Occasionally I come across a writer from a major financial paper, in this case the Wall Street Journal, who some how sneaks through the Editor in Chief's cheer leading requirements and puts out out a quality piece of analysis. Rather than summarize it, I attach it below in full text (as you may imagine, I agree with him entirely):


The Bernanke Market

We won't get real growth until Congress and Treasury get policy right.


I remember once buying the stock of a small company and I couldn't believe my luck. Every time my fund bought more shares the stock would go up. So we bought even more and the stock kept climbing. When we finally built our full position and stopped buying the stock started dropping, ending up at a price below where we started buying it. We were the market.

Just about every policy move to right the U.S. economy after the subprime sinking of the banking system has been a bust. We saved Bear Stearns. We let Lehman Brothers go. We forced Merrill Lynch, Wachovia and Washington Mutual into the hands of others. We took control of Fannie and Freddie and AIG and even own a few car companies, pumping them with high-test transfusions. None of this really helped.

We have a zero interest-rate policy. We guaranteed bank debt. We set up the Troubled Asset Relief Program (TARP) to buy toxic mortgage assets off bank balance sheets. But when banks refused to sell at fire sale prices, we just gave them the money instead. Dumb move. So we set up the Public-Private Investment Program to get private investors to buy these same toxic assets with government leverage, and still there are few sellers. Meanwhile, the $1 trillion federal deficit is crowding out private investment and the porky $787 billion stimulus hasn't translated into growth.

At the end of the day, only one thing has worked -- flooding the market with dollars. By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn't put money directly into the stock market but he didn't have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market.

The good news is that Mr. Bernanke got the major banks, except for Citigroup, recapitalized and with public money. June retail sales rose 0.6%. Housing starts jumped 17% month to month in May and will likely be flat for June. Second quarter GDP may be slightly up. And he was successful in spreading a "green shoots" psychology throughout the media. But the real question is, now what? Government interventions are only meant to light a fire under the real economy and unleash what John Maynard Keynes called our "animal spirits." But government dollars can't sustain growth.

Like it or not, the stock market is bigger than the Federal Reserve and the U.S. Treasury. The stock market anticipates only future profits and prosperity, not government-funded starter fluid. You can only fool it for so long. Unless there are real corporate profits from sustainable economic growth, the stock market is not going to play along. It's the ultimate Enforcer.

In mid-May, Mr. Bernanke's outlook seemed to change. Maybe he didn't approve of the sharp housing rebound -- like we need more houses! Maybe he saw inflation in commodity prices -- oil popping to $72 from $35. Or, more likely, he finally realized that he was the market and took his foot off the money accelerator, as evidenced in the contracting monetary base (see nearby chart). Sure enough, things rolled over -- the market dropped 7.5% from its peak, oil prices dropped almost 17%, and even gold has lost some of its luster. But in July, the Fed started buying again and the market rallied.

Can the U.S. economy stand on its own two feet without Mr. Bernanke's magic dollar dust? Eventually, but apparently not yet. Unemployment stubbornly hit 9.5% in June, according to the Bureau of Labor Statistics. Housing prices are still dropping, albeit at a slower pace, and foreclosures are still rampant.

But I think what really bothers the market is that the structural problems that got us into trouble in the first place still exist. We took the easy way out and, with the help of Treasury Secretary Tim Geithner's loose "stress tests," swept banking problems under the carpet. We waved off mark-to-market accounting and juiced bank stock prices to help them recapitalize, but all those toxic mortgage assets on bank balance sheets are still there as anchors on lending. All the pump priming and stock market flows didn't get rid of them.

Hats off to Mr. Bernanke for getting the worst behind us. He'll be pressured politically to keep pumping out dollars, but he should resist the urge. The stock market will ignore his dollars if it doesn't believe they'll turn into real profits. Green jobs and government health-care clerks do not make a productive, sustainable economy. That can only come from innovative companies with access to growth capital. The stock market won't turn bullish until it sees that type of economy.

Again, when it's clear that you are the market you have to stop buying and begin tackling the hard stuff. By not restructuring banks, by not getting bad loans off bank balance sheets, by not standing up to the massive increases in government debt crowding out private capital, the Fed and Treasury are holding back real economic growth. [END]

Thanks Mr, Kessler, real investors applaud you.

Build Value Every Day

Bradford van Siclen

No comments: