March 3, 2009
Good morning. The weekly report on “last” week is starting to sound very familiar, with no good news for the market to be found. “Last” week the S&P was down another 4.5%, down from $77.42 to $73.93, bringing the yearly drop to an astounding 18%. Reasons abound, a good example being the government revision of fourth quarter GDP numbers from a minus 3.2% annual growth to minus 6%, way more than most had envisioned. Add to that the large cut in the GE dividend, a negative reaction to increased future taxes in the President’s long-term budget, more bailout for AIG, I think we get the picture. Yesterday was a further acceleration to the downside, with the Dow down almost 300 points. The SPY was down another $3.33 to $70.60, bringing the SPY down a stunning 21.8% on the year. The VIX was actually down last week, before spiking to a close of 52.65 yesterday. Amazing that we can’t have a break in the bad news for even a puny bear market rally. Maybe this week?
Is there going to be light at the end of the tunnel (other than the headlight of the locomotive)? To be brutally honest, it is to be determined. The bad news just keeps on coming, the corporation appears broken, certainly in regards to any meaningful sort of corporate governance and/or control or participation by shareholders. As we have now passed through lows going back to 1997, investors at all levels are seriously questioning (and in many cases voting with their feet) whether the current corporate system deserves their investment dollars. I started in the business in 1981, and at that time the market had not shown any positive returns in over 13 years. The Dow was somewhere in the 700’s, after having broken 1,000 in the late 60’s, and interest rates were double digit. Only a “fool” would put his or her money in the market (which never went up) when you could make 10%+ in T-Bills. The point is that sentiment surrounding the stock market was seriously negative, but income was readily available through fixed income. Now sentiment is becoming more negative by the second, people are acutely aware that common stock investors have virtually no say in corporate leadership or profit participation, but there is no alternative income opportunity with risk free rates close to 1%. One political party pretended there was no malfeasance or common fraud going on among their constituents (big business), and the new party somehow sees governmental intervention as the answer. The current focus on how this wanton looting could occur is centering on lack of governmental regulation, but is that really the solution, more governmental involvement?
At some point I would hope that the focus turns to what really is the first line of regulation for corporate executives, the Corporate Board of Directors. These are the people charged with keeping management on track with the long-term best interests of the owners (shareholders). Over time that has come to mean (wrongly) the maximization of short-term best interests, like eagerly taking a bid of $20 just because the stock is currently trading $18. When I say long term I mean real long term, where the balances of being a solid employer, being a solid citizen, growing in a meaningful manner, doing real research, creating real wealth (as opposed to some invented useless thing like a CDO that can be made to show a profit and bonus when there was no profit), are properly balanced. How our supposed best and brightest (Alan Greenspan’s words to describe the C Board) were totally mesmerized by a set of carpetbagger CEOs will probably always remain a mystery. Regardless, new and current investors are sensing a problem, and are waiting for answers before committing money. Investors have been seriously burned, and are now asking the question “What is my share going forward and who looks out for me?” The last decade answer “You will get nothing, and like it!” (Quote provided by Judge Schmales from Caddyshack) does not seem good enough going forward. In the next positive business cycle I do not think, for example, the homebuilders will get away with huge profits for many years, huge bonuses, huge spending excesses, just plain dumb purchases, no dividends, and cratered stock prices as only the shareholders (the no dividend when things were going good shareholders) totally absorb the downside. I would also question the severe cut in the GE dividend last week with no corresponding cut in salaries. We need to find a way to put meaningful governance back in the Corporate Board system, or have we really lost across the spectrum of society the morality and courage to act that the current Corporate Board system demands? I would love your opinion on that.
We also have the governmental issue to deal with. Instead of putting blame where it should be, on management and some Boards, they are eagerly jumping into the abyss saying that they will be our saviors going forward. First of all, government regulation did nothing to help, and you could strongly make a case made things way worse. It is hard for anyone to think that doubling or tripling incompetence constitutes a solution. Maybe they should start where they have some competence, bringing to justice those that brought about the fraud. Really, a lot of the damage was outright fraud. Am I the only one that thinks the marking up of assets at Merrill and others, followed by bonuses on internally engineered gains is outright fraud? Maybe banning a whole bunch of incompetent Board members from other Boards for life would be a start, although the Chinese idea of a few executions thrown in might cause people to take a little more notice.
We also have the issue of a new President popping out a budget that seems to want to “fix” everything all at once. I applaud the move towards transparency and letting people know where you are heading, but in case you (Mr. President) did not notice most are pre-occupied with the current mess and are in no mood for further governmental overload. I will be all for common sense revisions in the tax code, but today is not the optimal time. We probably should stop paying wealthy farmers, and the mortgage interest deduction has always been somewhat of a strangely large perk, but not today. Let’s worry about it after I am sure I am not fighting for space under a bridge in 2011. Also, Mr. President, be aware that virtually no governmental regulation has been either efficient or effective, from the days of the CAB (Civil Aeronautics Board) and ICC (Interstate Commerce Commission) to the ridiculous performance of the current SEC and various bank examiners. Remember, there are three kinds of people in the world, some people make things happen, some people watch things happen, and some people wonder what happened. Regulators, as a group, have always been in slot number three.
How to make money? First we need to figure out what camp we are in. Camp number one says we are going to zero, a depression rather than recession is upon us, and we essentially need to go to ground. Camp two says that we may still fish for a bottom for a while, but we should stay in the market in a protected manner (doing our regular adjustments like rolling puts down) so that we can be in relatively good shape and in the market when people start looking past the current turmoil. I will say this. The market has performed so badly that I could not say that I could still be in (or stay in) the market if I (or my clients) were not protected to a large extent. If we did not have puts or put spreads providing some protection during these rough times I would have real problems telling people “Don’t worry, we are in for the long haul.” In fact, I could never say that, maybe I would have been the first one on the ledge. Since we are in relatively good shape, we need to think about opportunity being presented and when to commit excess cash to a market that is priced lower by the day.
When will that be? Dow 7,000, 6,000, 4,000, lower? Will we have a day to get in before a rally, or (let’s hope not) a decade? No one, despite the amount of informed opinions out there, knows. I am of the solid opinion that we are better off in and protected, and able to take advantage of high call premiums than being out. One issue that we are having is that it is hard to find calls to sell, as the puts get deeper in the money. Obviously the “trade” we are waiting for is to roll down the puts at or near the bottom and sell calls just above wherever the ensuing rally may take us. I think we are getting close, maybe this week.