Where Is Our Adult Supervision?
June 15, 2009
Good morning. Last week the market continued to advance, but at a very reduced rate. The SPY finished the week at 95.08, up from 94.55 or .05%, and is now up 5.3% from the 2008 close of 90.29. Rising commodity prices, especially oil, and a series of economic numbers that are showing generally a decreasing rate of deterioration seem to be fueling the rally. A few predictive type indicators, like consumer sentiment, have actually shown some improvement. The XLE, the oil segment of the S&P, advanced from 52.11 to 53.51, or 3.7% on the week and is up 12% on the year. The financial press, meaning everyone that can get to a microphone or other media outlet, is overwhelmingly declaring a new bull market and an end to the downturn. But is it?
There seems to be no doubt that the markets in general are in a lot better shape than the dark days on March. There has been a significant improvement in capital flows and things like overnight borrowing markets and bank credit markets seem to be functioning at least somewhat. Some banks have improved to the point where they are actually clamoring to pay back the government money, of course maybe not for the reasons most would like. The market has had a phenomenal run from the March 6 lows of 42%. The VIX index has dropped from the March highs in the low 50’s to under 30, still historically high but showing that a few people at least are willing to sell market insurance (in the form of puts) at “more normal” levels.
If everything is going so good, and everyone else (at least spouting their firm’s party line) is declaring victory, why am I so nervous? Could be several reasons, the first being that it is my job to protect as best I can the client money that has been entrusted to me. In that regard I am always going to be in the position of looking for the small but spreading leak in the boat on an otherwise sunny day (does not do much for the tan). Another is that I do not believe anyone telling you to buy stocks because that is the only thing he or she can offer in necessarily believable. The most important reasons, however, are that I do not think a lot of things causing the problems in the first place have been fixed; and that I think that we can actually improve some from the March situation only to find that the improved level is unsustainable. Probably a third is that we may be being artificially propped up by government money.
The first thing has to do with numbers and physics, as they apply to job numbers. We have lost over 7 million jobs since December 07, but the rate seems to have slowed with last months 345,000 loss vs. the 600+K monthly number we had been experiencing. There is no doubt that this number has to slow on the downside before we reach a stable level and eventually turn up, math does work that way. I do question the declaring victory part while jobs are still being lost, which appears to be what everyone is doing. Picture yourself in a plane in a steep dive, there is no doubt the first positive thing is that the rate of decline decreases, but it does not do you any good unless you get flat or go up before the ground arrives. Even if we start an improvement to average 400K a month for a while, then 350K, then 300K, it is improvement but the numbers even at that level are bad enough to cause problems. If we bottom out at 10-11M jobs lost (plus all the ancillary issues of part time vs. full time, who is counted in the work force, jobs at $10 hr. counted the same as $40 hr.) in the face of huge government spending I wonder if that hole might be just too deep. Plus I see no sign that the jobs most of these people have lost are ever going to call them back, and that all the potential new jobs seem to pay less. On the other hand, this is America, and we always have come back.
It seems everything sort of impacts something else. I spent some time at Notre Dame for a reunion last weekend. The good news is that a professor there used one of my quotes in Bloomberg as a question on an ethics part of an exam, and I was able to meet him. A great guy, and he has promised to keep me (and therefore you) up to date with all the current research into stock market movements and any option research they may be doing (in exchange for some guest lecturing on my part). We also talked about the subject of education in general, a timely topic since President Obama is urging people laid off to spend the time going to school and improving their marketability. I graduated Notre Dame in 1974, at a time when the economy was almost as bad as now, and that is essentially what I and some of my friends did, fled to grad school until things improved. The problem now is that an MBA might run $50,000 a year, a huge number for someone out of work, Law School the same. We have allowed the cost of higher education to run at roughly three times the CPI since 1974, so this Professor basically told me that the only people that can afford the $40,000 ND offsite program are those with business backing so they can write it off. How did we get here? We are throwing people out of work at a huge rate, dropping the pay of many others, then telling them to borrow massive amounts to improve and maybe get a job, if it does not work you create a huge debt load you can’t even dump in bankruptcy. Sometimes I think this must be a nightmare, and we will all wake up soon and discover there is some adult supervision someplace.
One sensitive but timely comment my Professor friend did make, and it is maybe more truthful than funny. We were discussing the role of cheating, lack of solid corporate governance, actual fraud, etc. (in other words, solid company for years, trades around $50, then you find out suddenly that they have millions of undisclosed losses on things you did not even know they were into, and stock plummets) on research into stock price movements. He did say that these things do cause serious discontinuities and can tend to mess up the research, imagine that. Anyway, we made it to the subject of Bernie Madoff. His comment was that Bernie’s investors; essentially feeling guaranteed 10% a year on some vague preferencing order flow trading strategy “Knew Bernie was cheating someone, to make those kinds of returns when no one else could, but were not happy when the people being cheated turned out to be them.” A little harsh maybe, but some truth.
So what about the market? As of now we are experiencing a solid sell off today, led by a lower Asian and commodity prices. I continue to think the market is fully priced here, that we have come back more than enough to reflect the general improvement since March. There is certainly plenty of room to advance further if this little pocket of improvement begins to spread, but I don’t really see it yet. It sure looks like a long way until the price of a newly built house can compete with the current market levels. I do think that at some point the number of cars scrapped/bought will cause people to need some new ones, but we are so saturated with cars it might take longer than most think. For the time being I would be comfortable putting a little more protected money in the market, since the cost of the put insurance is more manageable. I do not want to be actually short, just protected, and I want to continue to take advantage of this still high call premium.
On the radio show front, I am thinking of doing a half hour show in the morning with Tom Shanahan (probably 7-7:30 central) on the Internet, followed by a one-hour show around 11-12 with DRJ and PTI personnel, would be available live on the Internet, archived, mp3, and iPod. I would welcome your comments.