Nothing to Bet On

I don't remember the last time the market was up five days in a row. However, it was on declining volume and we're still in the previous churning range. Nothing to bet on yet.

The Bottom?

This is a chart of the Dow from 1982 to the present. It's a bit hard to read, but the important take away is that the Dow bounced right on the 50% retracement of the super-bull (the bull market that started in 1982.) The Fed has shown that it is willing to print as much money as it takes to keep the economy afloat. I guess this is good. It's possible that the government (the taxpayers) will end up making a ton of money in the long run for all the investments being made.

In the meantime, the Dow and the S&P are back in the October trading range. As for today and Friday, I don't put much weight on what happens during these two days (unless there is some big news.)

I hope everyone has a nice Thanksgiving. And, if you're not celebrating Thanksgiving then enjoy the day-off from the US markets.

Time to Be Bullish?

From Bloomberg:

Societe Generale SA strategist James Montier said he’s never been so bullish after the financial crisis dragged down prices for stocks, corporate bonds and inflation-protected government debt.

The Standard & Poor’s 500 Index is “distinctly cheap” because it trades for 15.4 times the 10-year moving average of its companies’ profits, compared with an average of 18 for the U.S. market since 1881, London-based Montier wrote in a research note today. Fifteen stocks in the U.S. index, from Chevron Corp. to Gap Inc., pass his test for “deep value,” while a tenth of shares in Europe and a fifth in Asia qualify.

House Prices in Florida

I grew up on the west coast of Florida and am visiting family here for Thanksgiving. I've seen many boom and bust periods here. This chart shows what has happened to prices in this area.

Auto Industry Reality

Peter Klein writes about the thriving auto industry in the US:

The proposed bailout of GM, Ford, and Chrysler overlooks an important fact. The US has one of the most vibrant, dynamic, and efficient automobile industries in the world. It produces several million cars, trucks, and SUVs per year, employing (in 2006) 402,800 Americans at an average salary of $63,358. That’s vehicle assembly alone; the rest of the supply chain employs even more people and generates more income. It’s an industry to be proud of. Its products are among the best in the world. Their names are Toyota, Honda, Nissan, BMW, Mercedes, Hyundai, Mazda, Mitsubishi, and Subaru.

Just Barely in the Range

The S&P is just barely back in the October range. I wont have much faith in this until the market closes above 900. Otherwise, the 2002 lows could easily be challenged again.

The Big Bailout

Here's a good (scary) summary of the money the government has spent or pledged to date.

Mortgage Market Recovery?

Businessweek reports on new subprime lending.

The local newspaper here in Florida had an article this morning on the recovery of the mortgage market (see Businessweek article.)

In Sarasota County, 402 homes sold in October, compared with 354 in September. Some were all-cash deals, but most were mortgage-backed. In Manatee County, 200 home sales closed in October, compared with 128 a year earlier.

"There's plenty of money after Fannie and Freddie became liquid again, and the Federal Housing Administration loans have always been a stalwart," said Flood, who recently established a Covenant Mortgage Corp. branch on Main Street.

Someone with the less-than-stellar credit score of 580 and a decent job will likely qualify for an FHA loan on a single-family home in this region for up to $442,500, Flood said.

Taking on Ben Stein

I was pleased to read Felix Salmon's take on Ben Stein. After showing that he had no clue about evolution he now comes clean in his misunderstanding of economics.

Thanksgiving Week

This week, I'm in Florida for Thanksgiving and time with my family. I will continue to follow the market and report but less frequently than usual.

The Morning Report

The market continues to like Geithner, which represents Obama taking charge, and all the money thrown at Citigroup. The futures are all up nicely in the pre-market.

However, as I repeat myself again, the Dow and the S&P500 did pierce their October trading range and challenged the 2002 lows, but recovered somewhat but are not yet firmly back in the range. The above chart is of the S&P at Friday's close.

The Market Likes Geithner

The market turned on its heels when it was announced that Tim Geithner would be Obama's Secretary of the Treasury. I think it's good for three reasons: 1) Geithner is already involved in the crisis and will hit the ground running; 2) At the NY Fed he can continue to work on issues before January 20th; and 3) The market just likes to know who is in charge.

The weekend question: Will the market follow through on Monday or is this just another one day wonder?

Is This the Best Time Ever for the US to Borrow Trillions?

Interest rates on US Treasuries are so low the government should be stockpiling borrowed cash. Also, read here.

Capitulation?

The stock market was ugly but it didn't seem uglier than other uglier days in terms of move and volume. However, it did seem that there was panic in the credit markets and this market is being driven by credit.

I've been writing that this market is oversold and it appears that it is bouncing this morning in the pre-market. For now, it is just a bounce in a bear market.

Compounding Harm

Let's do some S&P math (using round numbers):

For 2007 the S&P finished with earning of about $70 and a P/E of 21 for a index price of about 1470.

If the estimated earnings for 2009 are $50 ( a number I've been seeing lately) and the P/E remained at 20 then the index would be around 1000. However, P/E has been falling and 10 does not seem like an unreasonable number, that would reduce the S&P to 500. This brings us back to 1995, the year the slope of the index line increased its slope (see the above chart.) If both earnings and P/E fall by half their high then the S&P will sit around 350, a 75% fall.

How Much Uglier Can it Get

This is a chart of the Dow starting in about 1982, the beginning of the super-bull market to the present. At the current level, around 7500, the market is near or at its 1998 lows and its 2002 lows. Significantly, it is also a 50% retracement of the entire super-bull!

The S&P went through its 50% retracement today. If the Dow does not hold this level it could go to about 5900, a 60% retracement of the super-bull. That would bring the market back to its 1996 levels.

Deficit Spending

Matt Miller writes in Fortune about his conversion to a deficit spending proponent:

In the face of all this, how can a deficit hawk like me now blithely countenance the coming trillion-dollar gap? It's apt to invoke the godfather of deficit spending himself. "When the facts change, I change my mind," John Maynard Keynes once growled when grilled about an inconsistency. "What do you do, sir?"

Fair Valuation of the Market?

Here are two long term views of the Dow. The top chart shows the trend of the market prior to 1995 when its growth rate accelerated. If the market reverts back to the 1982-1995 growth rate and we project from 1995 to now, the chart indicates that a level of 7000-7500 is a reasonable valuation.

The bottom chart is a longer term view and is drawn on a log scale. It shows a price channel for the market from 1967 to now. This channel has held well over time. It is currently sitting at the bottom of the channel.

Where To From Here?

The S&P and the Nasdaq have closed below their October lows. The Dow had its lowest close but was still above the intra-day low of 7882. If the Dow ends lower, then the S&P and the Dow will attempt the 2002 lows of 768 and 7197 (these are intra-day lows.)

A Vicious Cycle

In talking with a friend yesterday, I mentioned that we have lived through events that always seemed at the time would forever alter our way of thinking and living, most recently, of course, 9/11 which was preceded by the bursting of the internet bubble. But, life pretty much returned to normal (aside from airport security, entering office building, going to stadium events and fear mongering as a political tactic) after a few years. I have not lived through a macro event that has profoundly change my life for the worse. In the past century, there was the Depression and the two World Wars, all of which I missed. Are we now experiencing such an event or will our economic life be back to normal within a few years? I can't answer that but what I can say is that it is easier to understand how a downward vicious cycle could play out then it is to create a scenario whereby life returns to normal.

Here's what I'm questioning: Are we starting a vicious economic cycle in which the contraction in liquidity, reduces consumer spending, reducing production, resulting in job losses, resulting in further reductions in spending, etc.

We are already experiencing the vicious cycle of asset deflation: falling prices causing margin calls which cause selling, pushing prices down, causing more margin calls, etc. Now here's how Paulson screwed up (just one of many ways): the original TARP was set up to buy mortgage backed securities from the banks. This provided some price support for that debt and at least temporarily shored up the banks and hedge funds. When he announced that he was scrapping that plan, the price support for those assets fell away and although I have no data to back this up, I believe it has caused more forced selling in the market.

One factor that I believe will slow down any recovery is that products last longer. The idea of built in obsolescence simply doesn't exist anymore - except for maybe ipods and cell phones. TVs, automobiles, refrigerators, ovens, blenders, have very long life spans. If people don't have the money and financing is hard, cars do not have to be replaced every three or four years for shiny new models and TVs and stereos seem to last forever. Better products and improved productivity in a contracting economy could further exasperate this downturn by further reducing manufacturing and increasing unemployment and depressing the economy.

I can only see two possibilities for an economic revival: 1) The developing and emerging markets grow and thrive without the US consumer, and 2) The US government invests heavily in large public service projects such as infrastructure and energy.

I honestly don't know what will play out and, let's face it, it is very difficult to know the long term effects of any event when you're in the middle of it.

As for the stock market, by every short term indication, it is way oversold.

One Barrier Falls

The S&P has taken out it's intra-day low and is heading to a new low for 2008 (the lowest since 2003.) The Dow will have it's lowest close but as of yet it has not taken out the intra-day low of 7882.

Berkshire Hathaway

For anyone watching BRKA, it looks like it's heading to 80,000. That will be a 47% decline from it's peak.

Yahoo's CEO Search

Securitization Mortgages. No Problem.

Contrary to the "hard" problem Paulson complains about and what all the talking heads on CNBC claim, according to Sheila Bair, the so called toxic mortgage debt that lives inside of securitized loans can be identified and modified. Read Sheila Bair's position in Joe Nocera's column.

Here's part of the response from the FDIC:

The F.D.I.C., however, begs to differ. As you’ll recall, the agency took over the California bank, IndyMac, which had, as Ms. Bair put it, “a pretty impaired portfolio.” It has since instituted a broad mortgage modification effort that also serves as a laboratory for what can and cannot be done. What the agency has discovered, said Mr. Krimminger, is that the contracts are rarely as constricting as investors and servicers have been portraying them. They do not allow principal reduction, for sure, but they almost never disallow interest rate reduction — or delaying principal payments for a short time. What’s more, Mr. Krimminger said, the servicer agreement simply says that the servicer’s job is to maximize the investment — which often means avoiding foreclosure.

Will the Market Hold These Lows?

The closing lows of the S&P form a very straight line. The futures in the pre-market are challenging these levels again. By any measure, the market is oversold but that's no guarantee of a bounce here. The economy is cooked for awhile. The question is what will earnings look like next year? And, with consumer pricing dropping (the biggest drop in 61 years!), can deflation be far behind.

The Lost Decade(s)

It's been noted that the Nasdaq is currently trading at its 1997 levels - ten years signifying nothing. I wrote previously about the similarity between the Nasdaq bubble and crash and the 1929 crash of the Dow. What I didn't mention is that it took the Dow 26 years to regain what it lost in the crash.

Dangerous Markets

As I said earlier, there is little conviction in the market. This kind of market can be dangerous. Volume is low and it's mostly sellers. In a market like this, it doesn't take many sellers to drive the market lower. Where are the buyers? My theory is that people are sitting and waiting for the next administration. This market could drift down until January 20th or Obama could announce the appointment of his economic team and provide some kind of road map for his plan of action. It seems the Bush team, Paulson in particular, has let it be known that they have done what they've done and they're leaving the rest to the next administration. All except for Sheila Bair, who continues to push for solving the root cause of this problem - bad mortgages.

Year End Rally?

Doug Kass, a long time bear, sees the opportunity for a year end rally.

Why Paulson Does not Support Help for Homeowners

From an interview with Deborah Solomon of the WSJ:

"Foreclosures are a significant problem, they're an economic problem," Mr. Paulson said. But finding a solution is complicated, he said, because "the issues then become, 'How effective are the individual programs going to be, where did the money go, is it going to banks or is it going to homeowners, and what's the cost-benefit analysis?'"

Isn't this his job? Does he only want to solve easy problems?

Pre-Market Outlook and a Plug for Sheila Bair

Yesterday succeeded in wiping out the entire gain from the monster move last Thursday. There is a total lack of conviction in this market. The pre-market has us sitting at the recent lows again. The futures were much more negative until HP announced earnings and beat expectations.

As I've said before, until the market breaks out of the trading range established in October, it's just a lot of flailing up and down. It does appear that the government has more or less succeeded in providing some stability to the financial industry. However, it could be argued that it is just a temporary band-aid. Institutions like Freddie, Fannie and AIG are still racking up big losses.

The big question is how bad will the economy get. There is no transparency on earnings, unemployment has not peaked, foreclosures are growing and there is no comprehensive plan in place to help homeowners. The only one who seems to be keeping her eye on the ball here is FDIC Chairwoman Sheila Bair but it's unclear how much support she has. After saving a few failing banks and now focusing on the underlying issues, she appears to be the most pragmatic, clear thinking person dealing with the crisis.

Government Sponsored Bankruptcy

Andrew Ross Sorkin makes a reasonable proposal for a Government Sponsored Bankruptcy of GM and Chrysler.

Profile of a Really Bad Market

There was a super bull market in the Dow from 1942 to 1966 (24 years). From 1966 to 1982 (16 years) the market melted down, again and again. The top chart shows the down drafts in the Dow during this period:

A. 26%
B. 37%
C. 46%
D. 26%
E. 20%

Then from 1982 to 2000 (18 years) another super bull. The second chart shows the down drafts since 2000:

F: 38%
G: 43% (to date)

Draw your own conclusion what the next 5 to 10 years may look like.

Auto Bailout and Transformation

Here's what might be in the congressional auto bailout bill according to the Washington Post.

Jeffrey Sachs writes about the opportunity to transformed the auto industry.

Efficiency Does Not Equal Reliability

James Surowiecki writes about the problems of efficiency in markets, like agriculture, where reliability is of equal or greater importance.

An Argument for Helping Detroit

Jonathon Cohn writes in the New Republic why bankruptcy of the Big 3 would not work as expected.

One reason for the casual support for letting GM fail is the assumption that bankruptcy would be no big deal: As USA Today editorialized recently, "Bankruptcy need not mean that the company disappears." But, while it's worked out that way for the airlines, among others, it's unlikely a GM business failure would play out in the same fashion. In order to seek so-called Chapter 11 status, a distressed company must find some way to operate while the bankruptcy court keeps creditors at bay. But GM can't build cars without parts, and it can't get parts without credit. Chapter 11 companies typically get that sort of credit from something called Debtor-in-Possession (DIP) loans. But the same Wall Street meltdown that has dragged down the economy and GM sales has also dried up the DIP money GM would need to operate.

That's why many analysts and scholars believe GM would likely end up in Chapter 7 bankruptcy, which would entail total liquidation. The company would close its doors, immediately throwing more than 100,000 people out of work. And, according to experts, the damage would spread quickly. Automobile parts suppliers in the United States rely disproportionately on GM's business to stay afloat. If GM shut down, many if not all of the suppliers would soon follow. Without parts, Chrysler, Ford, and eventually foreign-owned factories in the United States would have to cease operations. From Toledo to Tuscaloosa, the nation's?assembly lines could go silent, sending a chill through their local economies as the idled workers stopped spending money.

Weekend Reading

Gretchen Morgenson reports on an idea to purchase all mortgage backed securities, restructure all ARMs as 30 years fixed rate mortgages and sell the new debt. Easy as 1,2,3!

Businessweek goes undercover to report on sex in the mortgage broker business.

James Cooper writes about sinking corporate profits. This makes it very hard to understand if stock are fairly valued or not. The P/E ratio is meaningless without a good estimate for E.

David Yermack looks at the auto industry and the cost of a bailout.

And Iceland is still melting.

Another Retest?

The pre-market is looking like we'll get another retest of the October lows. The G20 meeting this weekend amounted to a lot of nothing. The question now is whether the world can wait for two months for some sort of coordinated action by the world's leaders?

For today, the thing to watch is if the market can exceed last Thursday's close. If not, it was just a one day wonder and lower lows may be in the cards.

Debt and The Economy

Here's something interesting to ponder. From the mid-1940's to 1980, government and public debt stayed relatively constant. The Dow during that same period went from about 150 to about 900, approximately a 600% increase in about 40 years. Starting in the early 80's both government and public debt started climbing dramatically and the Dow went from 900 to 14,000, a 1500% increase in 28 years.

If the economy's dramatic growth over the past 28 years was mostly driven by debt and not, as some would argue, productivity, what does this portent for the next 10 years?

Dizzy Day

After the morning profit taking, the market rallied nicely only to be felled by late in the day selling, taking it back to the lows of the day. The market is still in the trading range established in October. I find it hard to read much into the late selling other than market jitters before this weekend's G20 meeting.

Bretton Woods - the Sequel?

The G20 meets this weekend to see if an agreement can be made to mitigate the global economic crisis. The Economists has a good article about the prospects.

The summit is sure to stir up a debate about the institutions that oversee the international economy. By convening the G20 rather than the closed, rich club of the G7, the old order has in effect acknowledged that the rest of the world has become too important to bar from the room. But what new order should take its place? Answering that question has been a parlour game for economists since long before the crisis. By encouraging them to dust off their pet ideas, the summit will at the very least create a bull market in new schemes for global economic governance.

Understatement of the Day

From Paulson's interview on CNBC: "I'm looking forward to meeting my successor at Treasury."

Who's Laughing Now

At least one person saw this crisis coming. Watch a short history of Peter Schiff on CNBC and Fox News.

Auto Industry VII

Although a bailout appears unlikely in the immediate future, here's the argument for making it happen and avoiding Chapter 11.

Profit Taking

So far this morning, this is what I would expect as normal profit taking after yesterday's 10% move off the lows.

There is a big G20 meeting today and over the weekend and I don't think anyone wants to make any big bets in advance. Going out on a small limb, I think there is more of an upside bias going into the weekend because being short in the face of some sort of consensus announcement by the G20 seems risky.

Liberty Means Responsibility

"Liberty Means Responsibility, that's why most men dread it." - George Bernard Shaw

Floyd Norris writes today how no one in industry and no one in government is willing to take responsibility.

Bad Timing

Is Citi the next to go down? Here and here are good summaries of the issues.

Last night I get a call from my Merrill Lynch broker (and a FedEx package this morning) telling me that after much "research and reflection" he is moving his practice to Smith Barney (a division of Citigroup.) I am left with only one question for him: Are you kidding?

Base Camp

Need I say that yesterday was a powerful day and it was on big volume. The chart above is of the S&P. The lows of the year occurred on 10/10 and they have been retested twice and they may be retested again.

The market right now is not driven by fundamentals because there are no fundamentals to rely on. The market cannot be valued because no one has a clue what earnings will be next year. Aside from all the miserable economic news, the fact that no one can predict what will happen next traps the market in this trading range and increases the volatility.

A Measure of Volatility

It use to be (in the good ol' days) that daily moves of 1% or 2% would be considered big daily moves. Over the past forty trading days, the daily move of the Dow (from the low of the day to the high of the day) has averaged almost 5.7%. And, there have been five days with over 10% moves!

What a Retest!

This chart shows the Dow at 15 minute increments for today (up to 3:30pm.) Before the open this morning, I posted this as one possible scenario:

Or we could get a head fake: there are a lot of traders with stops just below this level. There is nothing market makers (or other large traders) like to do more than sell the market down to take out the stops and then reverse higher, so I would not be surprised to see a big down draft in the morning with a higher close by the end of the day.

I circled on the chart where the Dow broke the previous closing low. So far we have a 700 point rally (at 3:30pm).

Update (3:55pm): The Dow has moved more than 10% from its low of the day.

Auto Industry VI

Jim Manzi in the National Review Online makes a cogent argument for allowing GM to file for bankruptcy. He argues some of the same points that I made here.

Mid-Day Drop

The morning market was boring until a little while ago when it started to drop quickly and both the S&P and Dow have now broken their closing lows of October. See this morning's post for various scenarios from here.

Another Fine Mess

How many times in the past eight years have we been subject to big government programs without proper oversight? How much money has been wasted?

The Washington Post reports on the lack of oversight with TARP.

"It's a mess," said Eric M. Thorson, the Treasury Department's inspector general, who has been working to oversee the bailout program until the newly created position of special inspector general is filled. "I don't think anyone understands right now how we're going to do proper oversight of this thing."

Auto Industry V

Bailout or Bankruptcy discussed in the NY Times today. GM executives are spreading fear and speaking of the dire consequences of GM declaring bankruptcy - loss of millions of jobs, etc. The only thing that is sure is that the executives will lose their jobs. GM is not Lehman. GM will survive a bankruptcy. They will reorganize. They will slim down, renegotiate with the unions, focus their product line and generally reinvent themselves. Either the government can mandate all of these changes through law in exchange for bailing out GM or they can let the courts and bankruptcy process take its course. The latter, I believe, is a better option.

Testing the Lows

Both the Dow and the S&P are within spitting distance of their October closing lows. The top chart show the Dow and the bottom the S&P.

There is no telling what will happen now. The market is very over sold but that doesn't mean much with this much bearishness. The market could bounce todaywhich would be nice. It could just dive right through and go for the 2002 lows (see my October 16th post and October 10th post.) Or we could get a head fake: there are a lot of traders with stops just below this level. There is nothing market makers (or other large traders) like to do more than sell the market down to take out the stops and then reverse higher, so I would not be surprised to see a big down draft in the morning with a higher close by the end of the day. I would not bet on this, but it will be interesting to watch.

Auto Industry IV

James Surowiecki uses somewhat circular reasoning on his blog to justify bailing out the automakers. It may be true and if so, it only further justifies that in order to get taxpayer money, major restructuring and re-purposing needs to be a precondition. There is no precedent for us to trust the automakers.

Retest

The retest is coming. For the S&P it's about 840 and for the Dow 8175 was the low close in October but 7882 was the intraday low of 10/10. The government is appearing more and more like the boy with his fingers in the dike or maybe playing whack-a-mole, choose your metaphor for lack of a coherent plan.

1979 Redux

This from a 1979 Time article about the first Chrysler bailout.

The company specializes in making larger cars, vans and recreational vehicles. Since the gas crisis started, sales of these relics have, in lacocca's words, "been dropping like a rock." In this year's second quarter, unit sales were down 28% at Chrysler, compared with 27% at Ford and 15% at General Motors.


Did they or GM or Ford learn anything. Was it really worth it?

Auto Industry III

I agree with all of Thomas Friedman's anger and I can almost agree with his plan.

Confidence?

Paulson and company are not inspiring confidence when it appears that they don't know what problem they are trying to solve. Read here and here.

The New York Times

The NY Times was having problems before the economic crisis. Internet news and 24/7 cable news has eroded its ability (along with all other newspapers and many print magazines) to attract advertisers. I find this sad. For all the reading I do online, I still like reading the newspaper(s) in the morning, off line, sometimes sitting outside, with my morning coffee. Henry Blodget analyzes the financial position of the Times.

More on Not Supporting the Auto Bailout

From Megan McArdle at the Atlantic:

GM's operations are not otherwise sound. They have been headed for this moment since 1973. Conservatives blame legacy costs, and liberals blame management. They're both right. GM's legacy costs are crazy. So is the UAW leadership, which, goaded by the retirees, is knowingly driving the company into bankruptcy rather than negotiate clearly unsustainable deals.


GM's management seems to have a positive genius for making horrible cars, as if they'd deliberately sat down and asked themselves how they could best combine ugly, inconvenient, and unreliable into one expensive package.

Our Infantile Economy

When my kids started playing soccer at around the ages of six or seven, winning and losing didn't matter. At the end of the season, every kid received a trophy regardless of their team's record. This continued until they reached their teens. (The trophies became worthless dust collectors and eventually ended up in the garbage.)

In elementary school, their so called self-esteemed was enhanced by telling them that all their answers to questions were okay if they were well expressed. Communicating and collaboration were more important than correct answers (good skills - yes, but right answers do count.)

What's missing? Responsibility for training, learning, educating yourself to do well and know the right things to do. Self-esteem has replaced self-reliance as a goal of our education and society. What failed to be recognized is that self-reliance and responsibility lead to a level of justified self-esteem.

What does this have to do with the market and the economy? With bank bailouts, mortgage bailouts, automaker bailouts - is no one willing to accept responsibility for their actions? In the long run, is our society stronger or weaker if no one fails for their poor decisions and (I'm sorry to say this) their lack of financial knowledge.

Holding

The market had a mid-afternoon bounce after the refinancing news but then faded at the end. It is still holding its recent level. If this level fails then the October lows will most likely be tested.

Refinancing

New program just announced by Freddie and Fannie to restructure mortgages. They are hoping that the entire industry will follow their lead. Waiting to see if this moves the market this afternoon.

Auto Industry, again

I'll take support for my position against a bailout wherever I can get it. Read Henry Blodget's post.

The Market

Unless the market has a quick rebound, it looks like it will retest the recent lows. However, the bond market is closed today and that makes today an unreliable test of the market.

The Economy

There is almost no good economic news these days. Apparently, the only thing people are spending more money on are dollar value meals at Mikey D's.

The economy only does well when money is being spent and it can only come from three sources: consumers, businesses or governments. With property values down and consumers in debt, it's hard to imagine consumer spending picking up anytime soon, in fact, it may continue to contract. Business spending, typically, is predicated on demand and without demand from the consumer sector, business spending will be stagnant without some sort of outside stimulus. That leaves the government. The US has run up a huge deficit over the part eight years with much of it thrown into the money pit called Iraq. And, the profligate spending has been compounded by the Bush tax cuts.

One problem with government accounting is that there is no distinction made between operating expenditures and capital expenditures. If a corporation invests in a large piece of equipment, for accounting purposes, the cost of that equipment is spread out over many years; typically, the useful life of the equipment.

If we looked at government spending the same way and the government were to invest, in say, new roads, bridges, a new power grid, alternative energy development, these would all be investments that would have long useful lives. It half-a-trillion dollars were to be invested, it would make more sense for us to view this as an expense spread out over 15 or 20 years rather than adding that much money to our deficit in a single year.

The treasury should bring back long term bonds to finance the rebuilding of our infrastructure and to get us on the road to energy independence. This would also go a long way to rebooting the economy and strengthening our country at the same time.

Could Have Been Worse

Today could have been worse. The lows of the past two days were not broken and there is still a chance of maintaining a higher-low.

Stalled

I can only think of one reason the US government should bailout the US automakers - jobs. They have spent years making cars consumers don't want and fighting every effort to create more energy efficient cars. There is also the problem of the unions and the defined benefits the companies have been obligated to pay out. They are now stuck with lousy products, high fixed cost structure and a stinky economy - the perfect morass.

I believe that the companies need to be shrunk, maybe by half and the excess workers and manufacturing capability re-purposed for alternative energy and green technology development. The existing shareholders also need to take a significant hit - either wiped out or seriously diluted.

How Things Look From Here

This chart shows the Dow for the past month. Although the market appears to be going nowhere fast, the good news in this chart is that the Dow made a higher-high and may have made a higher-low. From a technical perspective this is a good thing. That being said, no celebrations until it gets above 10,000.

What I Read this Weekend

From the Wall Street Journal:

David Roche writes about the risks of deleveraging in Saturday's WSJ.

One of the risks is deflation and Yuka Hayashi writes about the worry in Japan about its return. Deflation is much worse than inflation in that deflation thrives on an pernicious feedback loop that is hard to break. With inflation consumers tend to buy now because they believe that prices will go up if they wait. This causes demand to rise and when it reaches the point where demand outstrips supply, prices rise. Inflation typically can be controlled by controlling the money supply - reduce the amount of money in the system and consumers cannot buy as much.

Deflation is the opposite. Consumers do not make purchases because they believe that prices will go down in the future. The problem is that simply by adding money to the system does not induce people to buy if they still believe that prices will continue to decline. The net effect is a shrinking economy, lower wages, etc.

Justin Lahart wrote about how the "free-market" thinkers of the Chicago School of Economics are becoming a bit more practical in their thinking.

From Businessweek:

And you thought Freddie and Fannie were the main mortgage oriented agencies in trouble - Peter Coy writes about The Federal Home Loan Bank, a federal institution that lends money to other banks for the purpose of issuing mortgages. It currently has $900 billion in outstanding loans.

From the New York Times:

Gretchen Morgenson (I wonder if she is enjoying being right about everything?) writes about the demise of Merrill Lynch. It's a great tutorial about how not to run a financial institution.

Finally, another article about the mess in Iceland with possibly the worst sentence published in the NY Times:

"Like the Vikings of 0ld, Icelandic bankers were roaming the world aggressively seizing business, pumping debt into the soufle of the system."


As far as I know, the Vikings were not from Iceland nor were they known for their soufles.

The Week End

We ended the day strong. More importantly, the Dow and the S&P held yesterday's low and closed above the 50% retracement I wrote about yesterday.

Obama Speaks

No specifics but I have one comment. He stated that the US auto industry is the backbone of US manufacturing. The problem is that it was in the 20th century but it won't and it should not be in he 21st century. Development of technology for energy independence should become the backbone of US manufacturing.

Waiting

This market is just sitting and waiting for Obama to speak. It's up but has been gliding for two hours.

The Return of Keynesian Economics

I'm not sure what Obama is going to say today but my guess is the next administration will have a full-on Keynesian approach to the economy.

Mail Bag

I received the following email in response to my post: Too Much Information.

Hi David,

If I understand correctly, the only way to make money on the market is to go against market rules and principles. And that electronic and computerized market places have made that a general law?
Very interesting

- Michel


Dear Michel -

My post was more about large institutional traders rather than individuals. The old ways of finding value in the market are gone because of the almost instantaneous delivery of financial data. Institutions have created new markets where data is not evenly distributed.

Individual traders can make money by understanding a simple fact: Until proven otherwise, fear and greed are the only constants in the market and when fear and greed rule, fundamentals don't matter for much.

My approach to the market is to attempt to measure levels of fear and greed and make trading decisions, both short and long term, based on those measurements.

When this market finally bottoms, fundamentals will be used to justify buying and those judgments will be correct because fear will have driven stocks to very cheap levels. However, as time goes on and the economy improves, investors will become less risk adverse and the measurements used to measure "value" will deteriorate to justify buying more. That is, until we reach the point where fundamentals are thrown out all together (See Internet Bubble and Housing Bubble.)

Ultimately, the way to survive the market is to think for yourself. Herd mentality works in the middle of long bull or bear runs but it doesn't work at the extreme. If you always follow the herd then you will be caught leaning the wrong way at the extremes.

Best,
David

Looking East

The Tokyo stock market, the Nikkei, is close to its level of 23 years ago. In the 80's, the Japanese economy was the talk of the world and the stock market reflected that until the real estate bubble in Japan sunk the economy. Japanese investors not only abandoned the stock market they abandoned spending regardless of how low the central bank lowered interest rates (they stopped at 0%), further hurting the economy. Although, the Japanese market is far from immune to the rest of the world, Japanese investors, large and small, are starting to buy stocks in numbers not seen in many years. Check out this article from today's NY Times.

Happy Birthday Joni

Read this 65th Birthday Tribute to Joni Mitchell.


And watch.

Leonardo of Pisa Would Have Been Proud

Leonardo of Pisa, also known as Fibonacci introduced Europe to the concept now know as the Fibonacci series. The ratio of one number in the series to the next forms a ratio that appears throughout nature. It defines the spiral shape of seashells as well as the ratio of the length of the human head, to the torso to the full body. The ratio is also useful in watching movements in the stock market. Take a look at yesterday and today's action for the SPY (S&P500 ETF). The dotted lines represent the Fibonacci levels between the recent low and high. As the the SPY declined it 1) bounced off the first level before continuing its decline; 2) it paused at the second level, the 50% level and 3)bounced significantly at the third level, went back to the second level and come back down. As a trader, I don't make bets based on this (I know people who do) but I find it fascinating to watch.

A Rest Stop Not A Brick Wall

Down through the 50% retracement but not without a rest. At this level the market paused and there was a bit of a fight between bulls and bears but bears won. Technical analysis does not deal in absolutes just probabilities and psychology. So today we saw the market pause at this psychological barrier. Now we look for a rest test of the recent lows.

The Past Week in 2 Minutes (Off-Topic)

Watch the last week of the election in 2 minutes:

Target

As I mentioned yesterday, I am thinking that the Dow will pull back to about 8900 giving up 50% of its gain from the past week. If it goes below that then it will probably retest the lows again.

Bizzare Episode on CNBC

I watch a lot of CNBC. Charlie Gasparino annoys me. He is often rude, he interrupts other guest, he talks over people and he's a rumor monger. Some blame him for the run on Bear Stearns. In the clip below, he totally loses it.

Perfect

Disappointments (Off-Topic)

My three election day disappointments:

1. Rep. Bachmann

2. Sen. Stevens

3. Prop 8

Not Holding

By mid-day its obvious that the market is not holding up. The chart above of the Dow shows the recent up move from a low 0f 8175 to 9625, that's 1450 points or 18%. That's a big move in 6 days. It would not be surprising for some profit taking here, maybe giving back 1/3 to 1/2.

Market Sense

We had a strong gap-up opening yesterday and a strong finish. Although the market is down so far today, it is still above yesterday's open and above the Halloween high. After the strong pre-election move yesterday, if the market stays in this range, it will be a good day.

Risk Models - Again

I wrote about the flaws of Risk Modeling a few days ago. Here's an article from the NY Times about this topic.

Yes We Did (and Song of the Day)

Yes We Can Can - The Pointer Sisters

And Yes We Did!

And from the NY Times:

"There is a country out there where tens of millions of white Christians, voting freely, select as their leader a black man of modest origin, the son of a Muslim. There is a place on Earth — call it America — where such a thing happens."

Cause and Effect

I wrote yesterday about the difference between correlation and cause. Today I came across this article on a study that shows a correlation between rainfall and autism. Apparently, there are higher levels of autism in rainy counties. So does rain cause autism? Here are a some unanswered questions that can give you an idea of the problem with studies like this:

1. Do people in rainy counties drink more?
2. Do people in rainy counties smoke more? Do more drugs? Take more anti-depressants?
3. Do they have children earlier in life or later in life?
4. Do they eat more meat?
5. What's the difference in levels of autism? Is it really statistically significant.
6. Do the same correlations exist in other parts of the world?

Information like this is less than useful.

The Obama Bounce

The Obama bounce is starting today but remember the market is still well within the October trading range. Also, remember, the market often buys the rumor and sells the news.

Too Much Information

Could it be that the current financial crisis was caused by too much information, not too little? James Surowiecki writes in this week's The New Yorker about more data not making investors any smarter.

Another related issue that I've thought about is the unintended consequences of too much information. The market has always been about arbitrage in one form or another. It's about finding investments that are mispriced and betting that eventually the market will correct the pricing. Value investing, the Graham/Buffet model is to find investments that are undervalued and betting that their value will rise. Shorting stocks is about finding investments that are overvalued and betting their value will fall.

On a more micro level, before the advent of electronic trading, traders on the market floor could make money by arbitraging the difference between bid and ask prices, the spread. Before electronic trading, spreads could be quite high but now, for a highly-liquid investment, spreads are mere pennies.

In the 1960s, Edward Thorp started one of the first hedge funds, Princeton/Newport Partners. He developed mathematical models to find arbitrage opportunities in the market. His fund returned over 15% a year for 19 years. The problem he ran into, and this is key, once others figured out what he was doing and started doing the same thing, the arbitrage opportunities evaporated. The mantra is - arbitrage only works if you know something others don't.

Online trading, complex computer programs that can sift through gigabytes of data, the instantaneous spread of information on the internet, have all combined to eliminate most opportunities to arbitrage.

So what is a large institutional investor to do to gain an advantage over other investors?

The answer is found in the wreckage of our current financial crisis. Create new trading instruments that are complicated, hard to analyze and hard to value. And finally, believe that you are better than others in figuring out to make money with them.

The institutions that created and were trading CDOs and CDSs (forms of credit derivatives) had a vested interest in not making the market transparent. If they believed that they knew more about the market than their competitors then they had the opportunity to make more money.

VOTE!

VOTE!!

Sitting Wondering Waiting

This is all the market is doing.

Risk Models and Portfolio Theory

Most investors probably have no idea what a risk model is but anyone who has ever worked with a stock broker probably has heard that smart investing requires a diversified portfolio. They've been told to invest in different segments of the market such as the U.S., Europe or Asian stock markets, maybe a small investment in commodities or REITS. Divide your money between growth and value stocks. Small-cap, mid-cap and large-cap stocks. Brokers probably brought out colorful charts showing how different markets have low correlation so that if one goes down the others don't.

Large financial institutions like banks and insurance companies developed complicated computer programs to slice and dice their investments to maximize their gains while minimizing their risks. And, as we now know it was all a house of cards that fell down - and here's why:

1. Correlation is based on statistics not cause and effect. In other words, just because two markets have historically behaved differently, there is no logic, science or force that will make them behave differently tomorrow.

2. When panic hits, everything is correlated. Proof: October, 2008.

3. Risk models are based on perfect information. There is an implied assumption that all information is known. Obviously, this is not true. In the current crisis, we still have no idea what the true magnitude of mortgage loss will be. On a much smaller scale, when evaluating the potential for investing in a company, do we ever really know all relevant financial detail of that company. Case in point - Enron. (I can hear someone saying: "Oh, but Enron was fraud. That doesn't count." I answer: Has there ever been a time where there has not been fraud in the financial markets?) Read this article. The father of modern portfolio theory, Harry Markowitz, says the only problem is transparency and proper oversight. Well maybe, but until that happens (which it won't) risk will never be mitigated in times of panic.

4. People are not rational. Read this article about AIG's risk models. A Yale professor named Gary Gordon developed these models. Here's the last paragraph of the article:

"On a rainy morning last week, Mr. Gordon briefly discussed with his Yale students how perplexing the struggles of the financial world have become. About 30 graduate students listened as Mr. Gordon lamented how problems in one sector caused investors to question value all across the board. Said Mr. Gordon: "There doesn't seem to be fundamental reason why.""

In other words, people are not making decisions in the way Mr. Gordon thinks they should. Risk models assume that investors make decisions strictly based on their own financial self-interest. However, people don't always behave rationally and for a risk model to even come close to working it has to model irrational human behavior and they don't.

Irrational human behavior always wins out both with upside bubbles and downside panics.

Cheap or Expensive. Buy-and-Hold or Time the Market.

Some things I read this weekend:

Historically stocks look cheap - read here from the WSJ.

But, if Deflation is a real risk, then nothing is cheap - read here from Businessweek.

And, maybe, buy-and-hold is not the best way to invest - read here from the NY Times.