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Archive for January, 2010

All of the analysts are out this morning describing last week as nothing more than the normal correction that we have been expected.  “Don’t panic – this is no big deal.”  “It is great to be normal again.”  To be fair, everyone who is bearish is calling for this bear market rally to be over and done.  So, who is right?  Corrections are normal.  The fact that we haven’t seen a correction is not normal.  So, welcome back to normal stock market activity.  At the same time, the charts are potentially showing a change of character in the market that would also support the bearish case. 

Every time the market changes direction, you have to look at the catalyst.  Unfortunately for the bullish case, the catalyst is Washington intervention and finger pointing.  Washington wants to assert control (continued move towards socialism) and wants to point the finger.  There were two news items beyond not so hot earning reports that had a negative effect on the markets.

First issue – On Thursday, President Barack Obama proposed new rules designed to restrict the size and activities of the U.S.’s biggest banks, the latest in a series of administration moves to curb Wall Street.

If you think back to last year, they forced all of the investment companies like Goldman Sachs and JP Morgan to be banks so that the Government could give them aid and help protect them from failing.  Well there is a price that comes along with that protection and it is called control.  Basically President Obama wants to tell banks how big they can be and tell them whether or not they can participate in what is called proprietary trading. 

Healthcare was only one of the ingredients of socialism.  Nationalization of the banking system is the other.  So, we just continue to follow their game plan.   Last year they took some major steps in gaining control over the banking system.   They performed an unnecessary stress test on the banking system last year in order to tell us (which was not necessary) the banks that were healthy and unhealthy.  They also announced a list of problems that might force the government to step and take over.

Well one of those problems is unemployment.  The government said that banks might have difficulty in an environment where we had a 10% unemployment rate.  Guess what our unemployment rate is today?  Yes, technically we are starting to meet the criteria as stated by Washington that would require them to assert control.  It makes you wonder if President Obama’s announcement last week was a reenergized effort towards nationalization of the banking system.  

As you might imagine, Wall Street wasn’t too happy with the President’s plan to assert control.  You can look at the stock market and the moment he stated that he no banks should be allowed to run proprietary trading systems and that he wanted to limit the size of banks, the market fell apart. 

This also gives the politicians during an election year the ability to point the finger at those big old bad banks that gave mortgages to people that couldn’t afford them.  Those bad banks are the problem and the Obama administration and Congress are going to correct the problem. 

Second issue – Members of Congress came out and declared that they would not vote for reappointment of Fed Chairman Ben Bernanke for another term.  This is the ultimate in finger pointing.  It is real convenient to blame him for the financial crisis and take the spotlight off of their part (the largest part of the blame) in the financial crisis.   Not reappointing him would be a grand mistake. These politicians are too interested in their own survival to realize the problems they will create in the markets by not reappointing him. 

This is the risk that we run into with the markets. You create problems when Government wants to fix things, assign blame, and start over regulating industry.  They don’t regulate when they need to and when they regulate they do it too much.

Politicians should practice preventative medicine to prevent the crisis from happening and never should be allowed to fix anything after it is broken.  You just have to look back to the Great Depression to see they same type of effect when they passed the Smoot-Hawley Act which many historians state made the Great Depression much worse.  

Once again, we come to the same conclusion.  These politicians seem to continue to be the problem.

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Financial analysts are now comparing our current stock market to that of 1982 drawing the conclusion that we are in a brand new long-term bull market cycle.  That would be great and all.  However, there are two main ingredients that are missing to make that assessment accurate. 

Back in 1982, the brand new bull market cycle started and lasted until 2000.  Today, the environment is not even remotely the type of environment that would support a new cycle.  Let’s start with interest rates.    The federal funds rate in 1982 was 18% and could only go down which would produce a boom in the economy.  Today we are at 0%.  The Fed has no place to go but up with interest rates.  The energy that a falling interest rate would produce to help buoy stocks just isn’t there.  This time around interest rates would act as a barrier to further growth. 

The other sticking point in the argument of a new bull market is the PE ratio.  I will resist getting into the mechanics of how a Price to Earnings Ratio works and its relation to the stock market.    The bottom line is that new bull markets start when PE ratios are low.  Bull markets end when the PE ratio gets too high.

 The top of the bull market in 2007         P/E was 25.5

The top of the bull market in 2000         P/E was 44.2 (due to internet bubble)

The top of the bull market in 1966         P/E was 24.1

The top of the bull market in 1937         P/E was 22.2

The top of the bull market in 1929         P/E was 32.5

The top of the bull market in 1902         P/E was 25.1

According to Robert Schuler’s valuation model which looks at reality and makes no assumptions about the future, the current P/E ratio is 25!  

This market is not cheap nor supportive of a new bull market. 

This week look out for earnings season.  We are in the beginning stages where companies report their good or bad news.  Thus far, earnings season has not been as expected.  Also keep an eye on the special elections in Massachusetts.  If the Republican wins that Senate seat, the Obama agenda would take a serious hit.  A win here by Republican Scott Brown would change everything.  I suspect the markets would like that outcome.   

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Out of the long list of risks and challenges facing the economy, the stock market, and investors, employment still remains near the top of the list. There were rumors all over Wall Street that the unemployment numbers would be positive for December.   With a big surprise and another sign that things are not getting better, 85,000 jobs were lost in December according to the “Government Accounting.” 

Yes, and the Government added around 59,000 fictitious jobs to the mix.  The Department of Labor’s unemployment rate, which includes much more of the workforce than the Government accounting, is creeping up closer to 18%.  I also like to follow Shadow Stats which has the most complete tracking.  They are looking at around 22%. 

However, there were was some bright news.  The Government went back and revised up 15,000 jobs from a -11,000 to a +4,000 jobs.  The talking heads on CNBC kept up the talk of recovery by pointing to the positive job numbers in November,  The funny thing is that they looked past the fact that Government revised DOWNWARD the job losses for October from 111,000 to 127,000 which sort of wipes out that positive job gain. 

The interesting little piece of data comes in this next unemployment report when they adjust the birth/date formula.  Remember that this is the formula that allows the government to add fictitious job growth to the overall number.  January is the month where they revise that number.  Over the past 5 Januarys, the loss of jobs reported by the birth/death ratio has resulted in an average lob loss of 276,000 jobs.  Given that job losses have not stopped along with the addition of the birth/death revision for January, that has the makings of a horrible number.

Incidentally, in the decade that has just ended, we created less than 500,000 jobs.  In the previous 4 decades, the economy generated at least 18 million jobs. 

Still there is no game plan for job creation other than the minimal impact from the stimulus package.  At some point the effects of this problem manifest itself in the stock market.  Until then, this market probably marches higher.  However, the biggest risk that awaits investors is the day reality of Main Street and the greed of Wall Street meet.  The problem is knowing when that will happen.  If and when it does, the level of risk should be through the roof.

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With a new year the predictions are everywhere.  Will the economy continue to stabilize? Will the stock market continue to go up? What are the pros saying? It is what they are saying as a majority that has me the most concerned. This is the time of the year where everyone is predicting how the new year will turn out. Personally, I am a recovering prognosticator and refuse to predict anymore after the bad predictions from last year. Granted, I was right about the first quarter and the continuation of the bear market. However, I couldn’t have been more wrong about what happened at the lowest point in March. So, let’s take a look at the prediction business and have some fun.

First, this is what concerns me. There is an old saying that goes like this – “When everyone thinks the same way, usually everyone is wrong.” Today everyone thinks there is no risk in the market. Everyone is bullish. In fact, today the level of optimism is higher than in October 2007 (top of the bull market), than in January 2000 (top of a bull market), and in August 1987 (two months before the second largest stock market crash on record.) When everyone is optimistic or pessimistic, things usually change. Danger – everyone is packed into a crowded party. What are you going to do when someone yells FIRE!?

Unusually High Levels of Optimism

I heard one analyst this morning who was just gushing with optimism about how high the stock market is going to go.  Then in the same breath he said: If we continue to see the same type of economic numbers going forward, I am very positive about the stock market.

Let me state the same thing in football terms. If the Dallas Cowboys continue to play the way they are playing now, I am very optimistic that they are going to the Super Bowl. What are the probabilities that the Cowboys are going to continue to play the same way? Minus the fact that Wade Phillips is unproven as a head coach that can take a team to the championship, I think that they are good. Things are clicking for the Cowboys. What are the chances that the economy is going to continue to improve? The economy is improving on the heels of a big shot of Government intervention that has created this false level of growth in the economy. I will not bore you with the long list of risks to investments today.

I will just ask one question. What are the chances that we just cruise on through without any ill effect of the debt crisis and continuing irresponsibility of the Government bail-out and cover up programs? Well, only time will tell. The quality of a prediction always comes down to the assumptions that are being made. I think that it is extremely risky to assume and base the fate of your investments on the probabilities that things are just going to run along smoothly in this economy when we face an unprecedented amount of challenges.

Next week – As I wrote earlier, I am out of the prediction business. However, I will present you next week with what I think are the probabilities for 2010 and what you need to put on your radar. Incidentally, tomorrow on the Prudent Money blog I will follow up with the counter argument to the point I am making today. Make sure and catch it.

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