Saturday, January 31, 2009

Friday, January 30, 2009

The Hope We Have Remaining Is Being Abandoned

The action this past week was a classic example of how we slide down the 'slope of hope' in a bear market. We started off the week well, with market players optimistic about the passage of a stimulus bill and a 'bad bank' solution for the credit markets. When it turned out that the stimulus bill was more pork than road building and the bad bank idea had no meat to it, the slide down the slope picked up steam.

The way the news flowed this week helped to destroy the fragile hope for a government solution that had been providing support. There are still those who want to believe that we are going to come up with some fairly painless cure for our economic ills, but it looks like there are more people who aren't so sure that is possible. The flaws in each plan just become more obvious as they become more specific.

The good news is that the major indices are still above the lows from earlier this month. I think the likelihood is that, at some point next week, the market will once again get excited over some new economic plan, which will cause another short-squeeze spike. That will keep the bears from getting too comfortable, but when it happens, we have to make sure we aren't too trusting too fast. It is going to take some time to restore some health to this market, especially after a day like this.

Someone Will Pay For The Banking Crisis In The US (Now Pick A Group Of People)

On Tuesday night, CNBC reported the rumor that a "bad bank" option was being considered by the Obama administration. The Wall Street Journal, The Washington Post, Reuters and various other news media confirmed that such a discussion was under way.

Just a few minutes ago, CNBC reported that that no weekend meetings are being held and that a "bad bank" plan is now on hold, as a variety of other initiatives are being considered.

So possibly the rumors were overblown in the first place, or the feedback on such a plan was so negative that the administration decided to drop the idea. Or, here's another explanation: possibly the administration underestimated the strength of the bankers' behavior of self-interest.

Frankly, the solution to the banking problem is a combination of time/price discovery. Someone is going to have to take the loss -- whether it be short-term, intermediate, or long-term in nature. Will it be the banks or the taxpayers?

Short-term, yes, someone books a "loss." If the government bought up all the crap assets at some model-induced price, the taxpayers would show a "loss" in the short and medium-term. However, these crap securities ARE paying. In the long-term, the taxpayer would book a "gain" (to just be wasted by the federal government of course). What would very well happen might be that the government could sell a significant number of these securities after a few years - at higher prices - when buyers realize these things are worth way more than .12 on the dollar, or .22 on the dollar, or whatever. The valuations attached to these securities as of this instance do not reflect reality at all (or most possible realities at least). In the meanwhile, the market is left without clarity or direction.

Wall Street Bonus Outrage

Back in 2007, it was apparent that the top brass of financial institutions were more concerned about their own bonuses than doing the prudent thing for their shareholders. Dilutive equity issuances would have hurt many of these executives at comp time. Thus they did not do the proper thing and make modestly dilutive stock issuances. These could have been done at far higher prices which would have created the liquidity necessary to work through the issues. I felt then,as I do today ,that this whole crisis could have been averted or at minimum substantially lessened. For example, deals could have been done with C at 46, BAC at 49, MS at 63, etc.

For political reasons, the new President pointed out yesterday that significant bonuses where still paid out last year. While I am generally opposed to grandstanding of this type, the political class is now doing something that the institutional investors should have done years ago. They are saying "enough is enough". The Wall Street leadership did not pay attention to the old rubric of bulls get a little, bears get a little, and hogs get slaughtered. Now their comp committee will have its meetings in Washington DC....

In my view Wall Street has been overpaid for decades. I have never subscribed to the notion that you have to pay these individuals or they will go someplace else. It is ridiculous. Even in the best of times that was a myth. A large percentage of these guys are professional Charlatans. Obviously the darkly comic John Thain interview earlier this week showed how out of touch these individuals are. It is truly an industry that, to say the least, is grossly out of touch with reality.

The reality is that most of these multi-million dollar investment bankers and traders are only as good as the name on their business card and the balance sheet they have access too. Yes,there are a few rainmakers. However,they are few and far between. As for the traders ,the system is totally skewed in terms of them taking excess risk. They win if the trades work and the firm loses if they don't.

This year was a once in a lifetime chance for the Street to get realistic on compensation. In my view there should have been zero bonuses paid across the board at all of the major firms with the sole exception being the profitable boutiques.

The argument frequently forwarded is what about the guys who did their jobs and were profitable in their business units. My view toward that is, yes that may be the case. However,their extra compensation is a function of the "bonus pool" and also the "franchise" and balance sheet. If the firms are losing money hand over fist and issuing stock to stay afloat there should be no bonus pool at all. Individual retail producers are different. They have lived off the land for years and have my complete respect for that.

At the end of the day it has now been shown that the world would be better off without about 90% of these people.

The Reporting On Job Losses Is Very Misleading

Pointing to a Dow Jones piece adding up the announced job losses this month, a popular approach that is actually very misleading. During the same period, the US economy created about 2 million new jobs, or about 100,000 for each business day. There are no headlines about this, because they are small increments in existing companies or new companies. The problem is the media focus on GROSS losses rather than NET losses. It is an incessant pounding that contributes to the negative feedback loop. Using actual state unemployment data from the last recession to analyze 2001, the net job loss for the year was about 3 million. The gross job loss was about 33 million. New job creation was 30 million. By taking the Dow Jones "add 'em up" approach, we make the problem seem ten times worse than it actually is. And please do not misunderstand. The job situation is bleak, as there is nothing good about monthly net losses exceeding 500K. It is also perfectly normal for media to report on layoff announcements. However, normal reporting tendencies exacerbate negativity.

Thursday, January 29, 2009

Boy, What A Difference A Day Makes!

After the hopeful action yesterday, today was very disappointing. Not only was there a lack of follow-through, but there were almost total reversals of just about everything. The financials didn't completely reverse, but they gave up a hefty chunk of their gains, which is good news compared to most other sectors of the market.

Breadth was around 4 to 1 negative, and the only sector to the upside was gold. The good news was that volume was quite light but that isn't anything to be too excited about.

The "bad bank" surprise yesterday provided a brief respite for the bulls, but today reality intruded and we had steady selling all day.

So now what? We are back in no-man's land for now, but we do have pretty clear parameters for downside support and upside resistance. The S&P 500 is now in a range with a top of about 875 and a bottom of a little over 800. I suspect we will have a bit more downside from here, but will look for the bulls to make a stand before we breach the annual lows. Keep an eye on gold. That is looking like the best sector at the moment.

Wednesday, January 28, 2009

Hope's Making A Comeback Baby!

For now, the market is celebrating the various government actions that are being taken to save us. I'm not sure that market players are all that confident that these are going to be effective solutions to our economic ills, but the fact that many want to believe it is enough to get us moving to the upside. We are climbing the slope of hope of today but it may of course become very slippery very fast.

News that the Obama administration is considering a "bad bank" program caught many market players by surprise and caused a sharp gap higher to start the day. With a FOMC interest rate announcement pending and a lot of trapped shorts, the bulls kept the pressure on all day. The Fed announcement offered nothing new, but the bears attempt to turn us back down was thwarted by some of the typical late buying we have seen lately.

Financials obviously led to the upside but breadth was excellent with only gold and bonds to the downside. Volume was mediocre but still sufficient to give us a technical "accumulation" day.

Are we now overbought? Probably. We did clear some technical resistance in the major indices at the 50-day simple moving average, but this was not a particularly impressive breakout move. I suspect many shorts were squeezed out today and will be looking to reposition themselves fairly soon. Should be an interesting couple of weeks.

Getting The 'Bad Bank' Solution To Work

The "aggregator bank" solution fits the strategy emerging for 2009 by both the Federal Reserve and the U.S. Treasury. In particular, both agencies appear interested in getting more bang for their buck, so to speak, in part because of public outcry over the use of the TARP. The goal now is to be more directly involved in getting money into the hands of those who want it.

For example, the Federal Reserve's upcoming $200 billion Term Asset-Backed Securities Loan Facility (TALF) will lend money to purchasers of asset-backed securities, money that will funnel through to consumers via credit card loans, car loans and leases, student loans and small business loans. The Fed said it could expand the program to include other areas of lending, including commercial mortgages.

The Fed has also been involved in the mortgage realm, having announced on Nov. 25 a plan to purchase up to $100 billion of agency securities and $500 billion of agency mortgage-backed securities. The plan, initiated in January, has resulted in a sharp decline in mortgage rates.

For its part, the Treasury could use the TARP in ways that are more likely to result in an increase in bank credit. One way is through the cordoning off of assets, which, as I said earlier today, would remove a barrier to the use of cash balances, whcih are now massive. Perhaps the Treasury can use its money to offer low-interest-rate mortgages and other loans.

One model aside from the FDIC's idea is for the Treasury to capitalize a special-purpose vehicle run by the Fed, a way of expanding the amount of assets that could be bought, thanks to the magic of the Fed's printing press. For example, the Treasury could inject $100 billion into the SPV, which could then purchase up to $1 trillion of assets. There are obviously many intricacies to such a plan that would have to be ironed out.

The FDIC has plenty of experience in handling bank crises, and under Sheila Bair it surely remains plenty capable. An FDIC paper written in 2000 and titled "The Cost of the Savings and Loan Crisis" put the number of failed thrifts at 1,043 for the years 1986-1995, with total assets for the failed banks at $500 billion. The cost to taxpayers was $124 billion.

How Cash Makes the 'Bad Bank' Plan Work

There has been a massive increase since August in the amount of cash held by U.S. commercial banks, a product of injections of cash into the banking system via the TARP and the Federal Reserve's creation of money. These injections have occurred against a backdrop of cautiousness among bankers who are rationally worried about further downward marks against their assets. Banks would more likely use their cash to increase lending if they worried less about their marks, and that is why the idea of corralling the assets is appealing.

Lending has the potential to increase substantially, because cash balances have increased from $800 billion to $1.1 trillion since August, an amount that using the standard multiplier could be turned into $8 trillion of bank credit. Obviously, this won't happen, but the point is that current cash levels are substantial enough to, at the minimum, normalize growth in bank credit.

An added force is the Federal Reserve's interest rate policy, which has driven yields on Treasury, agency and mortgage-backed securities to levels that are below the net interest margins that banks could earn on new loans. This is certainly the case for cash holdings, which, because of the Fed's "curse on cash," are earning banks next to nothing.

Series - Valuing Stocks

roic == nopat/invested capital

invested capital = total assets - all cash - nibcl

Tuesday, January 27, 2009

Not Very Convincing, But Not Bad Either

The stock market continues to see choppy, thin but generally positive action. We have been inching up on lower volume and good breadth, but we lack strong buying conviction. It hasn't been negative action, but it isn't very convincing either.

The Nasdaq has now had three up days in a row on declining volume and is close to hitting overhead resistance at its 50-day simple moving average. That is a potential short setup rather than a buyable pattern. The S&P 500 and DJIA are similar but don't have as clear overhead resistance.

The intraday patterns seem to indicate that day traders are dominating the action. They are buying pullbacks and then selling the minor rallies. We have an upside bias, but any sign of better momentum seems to invite profit-taking. The end result is very choppy trading.

We do have underlying support from dip buyers. Many of the financials -- such as JPM, GS, BAC, STT and so on -- have bearish patterns. With the major indices also setting up that way, I'm starting to look for some downside, but the dip buyers are likely going to keep it contained for a little while.

Morning Musings

Although the earnings news from this morning is far from inspiring, the weakness inherent in the results, comments and guidance hasn’t really been all that surprising.

Many technicians have been talking about how this market is in a sort of technical limbo right now. All in all, this earning season, so far, has failed to produce any major downside bombshells. In fact, reports from the likes of AAPL, GOOG and IBM have actually been rather decent. Sure, the ugly reports have triggered some losses in individual stocks – indicating that the bad news may not have been fully priced in on a company by company basis – but those losses have yet to really spill over into the broader market. The only really notable exception was GE last week, which ended up weighing down the industrials and, in turn, the Dow. Meanwhile, the overall news flow continues to be dismal, but that too has yet to really pressure this market lower.

The net result is a market that is barely clinging to tenuous technical support levels, which, if they fail, will mean that a possible trip to the November lows won’t be that far off. We still have plenty of room to move to the upside, but as we waffle around here close to recent lows, the oversold conditions we had at the beginning of last week are being worked off and that means the springboard from which we could have launched a nice rally has all the sudden become a lot less, well, springy. The problem, as we’ve seen, is a general lack of energy and an unwillingness for market players to push to the upside when they have the chance, and that can eventually cause folks to turn their eye towards shorting and/or selling into strength.

Perhaps market players are waiting for more clarity in regards to the stimulus package, or maybe they’re still wondering how any short-term boost the economy might get from all of the associated spending will balance against the nasty consequences that will surely come down the pike at a later date. Government actions never leave home without their trusty U.I.’s (or, “Unintended Consequences”) in tow, and you can bet that there will be plenty coming along for the ride with this one. Never mind the fact that most, if not all, of the actions are already pretty well anticipated.

The bottom line is that the bulls have a slight advantage here, but we’re still faced with a market full of traders looking to flip quickly in any strength, and until that changes, it’s going to be difficult for any momentum to the upside to build.

Monday, January 26, 2009

Running In Place

After a rather upbeat morning with all major sectors running higher, the financials stumbled, and we fell into the red momentarily. Of course, in this market, the traders jumped in as the day wore down and give us another big burst of volatility.

We ended the day with good breadth, but financials did not rebound that well after they dipped. Energy led and seems to be the go-to group for traders, but these stocks are still extremely choppy.

Overall, there was a lot of churning action, and the bulls couldn't get much traction, but there is obviously some underlying support as well. The market still has potential to build some upside here, but market players are lacking confidence, so we see some quick dips and volatile trading in the last hour. There is some foundation of support, but just not enough sustained buying vigor to get things moving.

I continue to want to add to holdings in closed-end funds, especially at a discount. Will we get another leg down to shake out the market further and bring in some real value buyers? Maybe, but at this point we just don't have momentum.

Friday, January 23, 2009

Very Weak Start (Was Someone Liquidated?), Decent Finish

Although the DJIA finished in the red, the S&P 500 and Nasdaq had fairly small gains and it was a good day for the bulls. We opened surprisingly weak as overseas markets dealt with a number of major economic issues. The dip buyers jumped in on the gap down and kept things moving to the upside for most of the day. Talk about the stimulus package helped in midafternoon and of course we had a little extra volatility in the final hour.

Gold was the big mover today as the dollar reversed down but oil and commodity-related stocks also benefited. Breadth continues to be on the weak side but almost all the major sectors were in the green.

Technically we are still holding support, which provides some optimism for a bit more of a bounce but there is not much energy and no leadership. However, I am encouraged by Kass on Real Money predicting a 5% to 10% bounce. We are lucky if we have a handful of stocks hitting new highs. Financials remain problematic especially GE and there are obviously a lot of issues in the United Kingdom that can cause some drama.

Many are complaining how much work this market has been. Trying to grind out some gains is extremely tough and it is wearing on a lot of folks. Please. Go try working in a mine if you want to really define "work." Sorry about that. Back to the subject at hand - It isn't that they are losing money, but they just aren't getting much upside traction and the time frames are so short that it's a lot of extra work. That is the way it goes sometimes.

don't really mean to pick on buffett today, but....

berkshire stock's not doing well these days. since late summer '08, it has fallen from about $140,000/share to about $89,000 or so. plus, and more importantly, there has been rather shocking deterioration of berkshire's investments.

in the last 60 days, berkshire's investment portfolio
has plummeted in value. buffett has lost over $4.5
billion alone on his 300 million share investment in wfc since 12/1/08, and another $1
billion loss on usb shares; both
stocks have been halved in less than two months. his
most recent investments in bni, ge and gs have deteriorated markedly in value from his cost basis.

equally important, i believe that berkshire's large derivative position -- namely,
short puts on the S&P 500 -- was evidence of investment
style drift. regardless of that view, berkshire has now
likely recorded a nonrealized loss in excess of a $10
billion on the index short put position. A loss on that
scale, whether realized or unrealized, is large even for
warren buffett.

moreover, the us "economic pearl harbor" (as buffett himself recently put it) has humanized
and brought down to earth many of the smartest investors
in the world (e.g., buffett), as well as the
entire private equity universe, many well-regarded hedge
funds and investors (e.g., marty whitman and bill miller), and some masters of the universe in residential
and nonresidential real estate, among others (zell). many
industrialists, including aubrey mcClendon, kerkorian, adelson and redstone,
have been thrown under mr. market's bus, as have
financiers fuld, cayne, thain and bac's lewis.

while a downfall of a widening list of investment,
financial and industrial icons have historically been
associated with a market and economic bottom, the lesson
remains the same: the average individual investor might want to continue to err on the side of conservatism in a market
that provides a wonderful setting for trading but a
not-so-exquisite setting for investing.

ge and buffett

ge's getting buffetted (ha ha) today; down about 11%; after saying of course they expect more credit losses in 2009. duh. buffett had great things to say about ge not that long ago; where is he now? if he loved it 25% or 30% higher, why not buy more now?

Thursday, January 22, 2009

Accounting Is Too Important To Be Left To Accountants


* Mark to market accounting is crippling the economy.
* Historical-cost accounting is more transparant.
* Accounting is too important to be left up to the accountants.

President Obama's highest priority needs to be reviving the economy. If he doesn't get economic policy right, little else on his agenda will be possible.

One step he should take immediately: Call upon the Securities and Exchange Commission to suspend without delay the system of mark-to-market accounting (specifically SFAS 157) adopted in 2006 by the Financial Accounting Standards Board. This rule is a major cause of the global financial crisis.

I confess that I considered advocating mark-to-market accounting when I was chairman of the Federal Deposit Insurance Corp. during the banking crisis of the 1980s. One of the many problems we faced then was the massive insolvency of thrifts due to their holdings of long-term, fixed-rate mortgages at a time of very high interest rates. I thought mark-to-market accounting might force banks to keep the maturities of their assets and liabilities in better balance.

The FDIC ultimately rejected the notion for three reasons. First, mark-to-market accounting could be implemented on only a portion of the asset side of bank balance sheets -- it was daunting to even contemplate the liability side. A system that captures one change in value without picking up other changes can be very misleading.

Second, we believed that mark-to-market accounting would impede banks in performing their fundamental function: taking short-term money from depositors and converting it into longer-term loans.

Third, we felt that mark-to-market accounting would be pro-cyclical, making it difficult for regulators to manage future banking crises. If we had followed mark-to-market accounting during the 1980s, we would have forced the nationalization of our largest banks, which were loaded up with Third World debt for which the markets were not functioning. Thousands of additional banks and thrifts would have failed because their long-term assets were under water due to exceedingly high interest rates. The country would have gone from a serious recession into a depression.

Mark-to-market accounting has destroyed hundreds of billions of dollars of capital during the past two years and has depleted lending capacity by 10 times that amount. We can't rebuild the economy unless banks are willing and able to lend again. Devotees of mark-to-market accounting cringe at the thought of suspending the rules. They argue it would result in a loss of transparency and an overstatement of values.

To the contrary, mark-to-market accounting has produced terribly misleading disclosures by valuing assets well below their true economic value. It is transparently bad accounting.

If the SEC suspends SFAS 157, banks and their regulators will value the affected assets the same way they value all the other assets on banks' books. They will consider the cash flows on the assets, the likelihood of defaults and the probable losses. Valuations and disclosures will be improved, not obscured.

Historical-cost accounting -- the cornerstone of generally accepted accounting principles -- is vastly superior. Under historical-cost accounting, marketable assets are carried on the books at their amortized cost, and the balance sheet contains footnoted tables showing the current market value of those portfolios. This gives investors all necessary information to evaluate the adequacy of a bank's capital and its earnings power.

Historical-cost accounting does not run market depreciation through the income statement and does not deplete bank capital (unless the decline in value is considered permanent). This system provides a more accurate financial picture of a bank than the SFAS 157 rules and does not destroy bank lending capacity.

The worldwide financial crisis demonstrates that major principles of accounting are much too important to be left solely to accountants -- or, worse yet, to an international board of accountants, as the SEC is considering.

We need to change our system of setting accounting standards to make it more accountable. Accounting principles affecting our financial system should require approval from both the Federal Reserve and the FDIC -- the two agencies charged with maintaining stability and picking up the pieces when a crisis hits.

It makes no sense to allow the SEC and the FASB to continue their senseless destruction of capital in our banks at the same time Treasury is using taxpayer money to recapitalize the very same banks.

Fair-Value Accounting: A Matter Of Interpretation


* Many blame fair-value accounting for making the meltdown worse.
* Critics argue it’s an expression of the free market faith.
* Proponents say it’s the best valuation method, and there’s no alternative.

"What's the price of a house?" asks Howard Marks, chairman of Oaktree Capital Management LP. The simple question, he says, has no easy answer. Is the price of a house what you paid for it? Is it the price for which you can sell it today? Is it the replacement cost, assuming the house was destroyed, or the amount it would fetch, discounting taxes and other fees, if you held on to it and then sold it in ten years? Marks suggests each of those is the price of the house. The one you pick depends on your perspective and your need. "In fact, there is no one price for anything," he says. "Price is a gaseous cloud."
For financial market regulators, auditors and accountants, however, the answer is clear. There is only one price for an asset: the price for which it can be sold, right now. This accounting regime, popularly known as mark-to-market and officially as fair-value accounting, has been the standard in financial reporting since the early 1990s. Its predominance over other forms of valuation has expanded over the past 20 years, and the Financial Accounting Standards Board confirmed it in September 2006 with the issuance of Financial Accounting Standards No. 157, which defined how to measure fair value.
-- Browse other stories in this Deal Economy Preview --
A matter of interpretation
Reining in the meltdown's 'catastrophic enabler'
They need a new drug
Parisian views
Although questions of accounting are often arcane and technical, and consequently often ignored by investors (not to mention the general populace), few subjects have received as much attention in recent months as marking to market. If the past year is any guide, few topics will receive as much focus in the months ahead.

Already, the fair-value accounting rule has been the subject of countless editorials, columns and blogs, either loudly defending it as the only thing keeping the U.S. from sliding into a Japan-style, decade-long economic morass or decrying it for unnecessarily making a bad financial crisis much worse. Voluminous analyst reports have dissected each loophole and exemption the rule offers, academics have analyzed its effects on liquidity and leverage and even Congress itself has plowed into the issue, officially mandating as part of its $700 billion bailout package a study by the Securities and Exchange Commission on how mark-to-market accounting is affecting the economic crisis.

The rule has become a flash point for fundamental questions about our financial system. In fact, the debate around fair value has taken on the air of an ideological struggle, touching on matters of fairness, judgment, truth and the role of the markets in the economy.

"It is horrendously bad accounting," says William Isaac, a former chairman of the Federal Deposit Insurance Corp. who now runs Vienna, Va., financial services consulting firm Secura Group LLC. Isaac says he first became opposed to fair-value accounting in the early 1980s, when he was still FDIC chairman, and has emerged in the current crisis as perhaps the most vocal critic of the standard. "Market-value accounting is based on highly emotional market swings that can reverse themselves quite easily once the emotion wears off. We can destroy bank earnings and capital in massive amounts based on such wide temporary swings in market prices."

To understand Isaac's criticism, it is necessary to understand how fair-value accounting works. As it has been structured by the FASB, a private-sector group that acts as the SEC's proxy in accounting matters, fair-value accounting forces companies to value many of their assets at the price they would fetch if they were sold in open markets.

According to FASB's rules, if a security is sold in an orderly manner (meaning not as part of a fire sale or liquidation), then the sale establishes a mark, or a price, effectively setting valuations for anyone who holds the same securities.

The standard was first issued in September 2006 and came into effect for financial assets and liabilities for fiscal years beginning after Nov. 15, 2007. Most companies adopted the standard early.

The rules are applied differently for different sorts of financial firms. All broker-dealers, for example, must use fair-value measurements, while commercial banks only have to do so for securities or loans they are looking to trade or sell. Assets held to maturity can be carried at cost but must be written down if they are deemed impaired.

Of course, this doesn't mean that the financial industry is unaffected. There is the reality that a move toward the market-driven ethos has changed the fundamental nature of banking from a long-term, value-driven approach to one emphasizing speculative activity. As former Comptroller of the Currency Eugene A. Ludwig put it in congressional testimony in October, "We have today turned every transaction in our capital markets into a 'trade.' People, customers, relationships are secondary if they exist at all; everything is a valueless, faceless trade. This somewhat desiccated system in my view breeds outsized risk and runs counter to the fundamentals of a sound financial system where service and the customer should matter a great deal."

Aside from this secular shift, fair-value accounting has complicated mergers in banking. And the largest commercial banks, such as Citigroup Inc. and J.P. Morgan Chase & Co., have large trading and investment banking arms and consequently need to mark a large portion of their assets and liabilities to market, which directly affects their earnings and consequently their capital.

Despite the complexities of the accounting, the debate over mark to market hangs on a relatively simple argument about the essential nature of the market. At the heart of fair-value theory is the efficient-market hypothesis. This is the belief that market prices are the best gauge of value because they reflect the collective judgment of the investing universe and thus the most relevant and accurate information about securities available at any given moment. The crowd opposing broad use of mark to market takes the opposite tack: That the market is often skewed, swept by emotion or prone to bubbles, dislocations and breakdowns.

But is the market always right? What does it mean to be "right?" These questions capture the conflict between pro and con factions in the mark-to-market debate today.

Put it another way: Does the market price always accurately reflect fundamental value? And what about those extreme circumstances where markets are illiquid and barely function, beset by a lack of buyers and sellers?

Take, for example, Merrill Lynch & Co.'s decision last July to sell a notional $30.6 billion portfolio of mortgage-backed securities to Lone Star Funds for 22 cents on the dollar. At the time of the sale, the housing crisis was well into its second year, and the market for mortgage-backed securities had all but collapsed. That sent valuations, even for super-senior tranches of asset-backed collateralized debt obligations that Merrill was peddling, to extremely low levels. In fact, before the sale, Merrill had already written down the securities to 36 cents on the dollar.

But Merrill was a motivated seller, betting that taking a write-off now, even at such distressed levels, would be better than watching its capital continue to deteriorate if the securities kept falling in value.

According to Merrill's third-quarter earnings report, it booked a loss of $4.4 billion on the sale but reduced its exposure to the asset class by $11.1 billion.

Still, there is some reason to believe the price set by the Merrill sale was an inaccurate estimation of its value, at least in fundamental terms. According to Franklin Allen, a finance and economics professor at the Wharton School of the University of Pennsylvania, if 100% of the mortgages backing the Merrill CDOs defaulted, the houses that ultimately backed the securities would have to sell at 22% of their original price to meet the value implied by the sale. In other words, housing prices would have to fall 78% for the mark to accurately reflect the fundamental value of the securities sold by Merrill.

"Even today, it's difficult to take the numbers and believe it is going to be that bad," Allen says. At the time of Merrill's sale, home prices nationwide had fallen about 22% from their peak, according to the Standard & Poor's/Case-Schiller Home Price Index. As of October, prices had slipped 25%.

But, as Glenn Schorr, an analyst for UBS, put it at the time: "While these are Merrill-specific deals, they do have the potential to create marks and put pressure on some other companies to derisk their balance sheets and take their lumps in an effort to move forward."

Following Merrill's sale, several large banks absorbed heavy losses, based largely on mortgage-related write-downs. The most dramatic, of course, came from Lehman Brothers Holdings Inc., which announced a $3.9 billion third-quarter loss on Sept. 10. According to the firm, the loss came on the back of a $7.8 billion write-down on its commercial and real estate mortgage-related securities. The announcement was Lehman's last before it filed for bankruptcy on Sept. 15.

This is not to say that Merrill's CDO sale led directly to Lehman's bankruptcy, but the undeniable broader effect of Merrill's transaction is indicative of one of the main criticisms of mark-to-market accounting today.

"Some observers suggest that fair value promotes a downward spiral in prices and investor confidence," wrote Raymond Beier, strategic analysis group leader at PricewatershouseCoopers LLP in a white paper on the subject published in September.

"As financial institutions take write-downs when prices drop, they may be forced to sell off assets to maintain compliance with regulatory capital requirements. The result is continuing downward pressure on pricing."

This phenomenon of heightening market cycles, both on the way up and the way down, is known as procyclicality. Downward procyclicality, prompted by fair-value rules, presents a huge problem, while fair value in rising markets arguably promotes an upward procycality that may contribute to the inflation of market bubbles. "Both are highly procyclical, and both are very harmful to the banking system and the economy," Isaac says.

For the large banks, continuing write-downs have seriously damaged their earnings, which has eroded their capital bases. This has created a scramble to raise capital, either through the banks selling assets, further dampening prices, or by selling stakes in the institutions themselves, often at onerous terms. The result: a self-reinforcing negative cycle that has shown no signs yet of bottoming out.

"Mark to market creates that appearance of instability in the financial system that maybe shouldn't be there," says John Castle, chairman of New York private equity firm Castle Harlan Inc.

In the case of smaller banks, which are not as directly affected by fair-value measurements, at least in terms of the securities and loans they hold on their books, the use of a mark-to-market-based purchase accounting has made it more difficult for institutions hurt by the decline in the broader economy to find merger partners.

"This contagion is a nightmare," says one attorney who specializes in banking mergers. He says that in more normal times, struggling banks hit by losses on real estate loans might have looked to merge with stronger institutions as a way out of their problems. But mark-to-market rules are even complicating that potential solution, as acquiring banks are forced under purchase accounting to mark the target's assets and liabilities to market. In today's environment, this is forcing acquirers to immediately raise more capital to cover the paper losses they would assume.

This is what happened when Pittsburgh's PNC Financial Services Group Inc. acquired Cleveland-based National City Corp. for $5.2 billion in October. PNC had to borrow about $7.7 billion from the federal government's Troubled Asset Relief Program to bolster its capital after the purchase. In fact, sources say PNC would not have been able to complete the deal without the TARP funds.

The accounting regime, another banking attorney adds, is forcing a regulatory response based not necessarily on the banks' fundamental strength, or lack thereof, but on the market perception of the business. The two, the attorney argues, are not necessarily the same thing. "Fundamental issues of policy shouldn't be decided by the people in Norwalk," the attorney says, referring to FASB's Norwalk, Conn., headquarters. "The markets are so thin today, they're totally inaccurate."

Isaac, for his part, put it this way at an SEC roundtable in August: "We have one hand of the government, the Treasury, handing out capital just about as fast as the SEC and FASB is destroying it with mark-to-market accounting."

But what are the alternatives?

For fair-value proponents, there aren't any, even though some acknowledge the difficulties the accounting system is creating. As Treasury Secretary Henry Paulson said in a Nov. 20 speech, "mark-to-market accounting is clearly procyclical. Yet I know of no better accounting method."

That no other accounting system works as well seems to be taken for granted among fair-value boosters. "There is a clear bias against marking to market," says one lawyer who advises corporate boards. "But the strongest argument for mark to market is that there isn't a strong alternative."

Proponents defend the system by claiming that it provides greater transparency to investors and shouldn't be blamed for exposing problems on the banks' books that might have been ignored otherwise. "Ignore current market/fair value at your peril for it may provide a critical signal of underlying problems and truths," FASB chairman Robert Herz said in a Dec. 8 speech. "So can we handle the truth? Side-stepping the truth by blaming the accounting as misportraying reality and causing 'procyclical' effects is tantamount to trying to 'shoot the messenger.' "

Herz's call to truth is very suggestive. It implies that fair-value accounting is the only clear looking glass through which the reality of companies' balance sheets can be revealed.

But this was not always seen as the case. In fact, the move to fair-value accounting is less than 20 years old, when it was reintroduced by regulators as a reaction to the system that had been in place for 40 years prior, that of historic cost accounting.

Under the historic method, financial instruments were valued at the price at which they were bought. Only when they were sold, or deemed impaired by auditors, was the price changed. As FAS 157 states, "The definition [of fair value] focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price.)"

Ironically, regulators initially installed historic cost accounting during the Great Depression as a reaction against mark-to-market principles and as a way of encouraging conservative investment practices. They felt that mark-to-market accounting, which banks were then using to value their investment portfolios, encouraged them to chase speculative gains at the expense of long-term value. Like many of the New Deal-era markets and banking regulations that have been steadily rolled back since the early 1980s, historic cost accounting was seen as a way of saving the market from its own excesses.

But that changed in the 1980s during the rise of the free-market ethos that placed investors above every other economic actor.

Financial regulators blamed historic cost for allowing the country's savings and loans to hide real estate losses on their books from investors and reintroduced mark to market through a series of FASB statements. These culminated in statement 157, which defines fair value and provides guidelines on how to measure it.

The Japanese experience in the '90s illustrates the main problem with historic cost accounting. Fair-value proponents regularly bring up the specter of Japan's lost decade as an example of what might happen here were it not for the discipline imposed on companies through mark-to-market practices.

As the theory goes, Japanese regulators did not impose fair-value methods upon the banks after the real estate bust that ended the 1980s boom. Because of this the banking system was able to stumble along holding bad loans on its books at cost. While this kept the banks from failing, it also discouraged them from shedding their bad loans. In effect, the banks were not well capitalized, regardless of what the accounting said.The poison of bad loans remained in the system for years, effectively sapping Japanese economic growth. According to this view, mark to market would have forced a reckoning for the country's banks, outside of any political or earnings-related pressures.

"I question those who say that hiding things will solve our problems," says Espen Robak, president of New York-based Pluris Valuation Advisors LLC, which values illiquid securities for hedge funds and broker-dealers. "I hope we don't get stuck in the muck like Japan."

hat seems unlikely, however. Even Isaac admits that a return to historic cost accounting would be difficult to implement, given that investors already have some sense of the market values of the assets and liabilities on banks' books. "I concede that, having made this colossal mistake, it's really difficult to unscramble the mess," he says. However, he continues to advocate a suspension of fair-value accounting in favor of a government-led effort to value banks' books.

"We can start by having regulators go in and do an economic analysis of the portfolios and mark them to that analysis," he says. "It's a big job, but they clearly have the resources to do it."

There are few indications that regulators are willing to consider Isaac's proposal. In fact, the opposite seems to be happening, at least on the surface.

The SEC on Dec. 31 issued a congressionally mandated report on mark-to-market accounting in which the agency recommended against suspending fair-value rules. The SEC argued that fair-value accounting increases transparency and helps investors make better decisions. In fact, the report went on to deny any effect from fair-value accounting on the financial crisis.

"Fair-value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008," the SEC said. "Bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and in certain cases, eroding lender and investor confidence."

Accounting industry group Center for Audit Quality hailed the SEC report. "I am pleased to see that the SEC staff has concluded that a suspension of fair value or 'mark-to-market' accounting is inadvisable," executive director Cindy Fornelli said in a statement.

But, despite the SEC's seeming intransigence -- for now, it's unclear whether the agency's stance will change after Mary Schapiro takes over from Christopher Cox in the Obama administration -- there are indications that FASB is moving to some sort of a hybrid reporting structure. Accounting and tax adviser Robert Willens says recent amendments to fair-value rules suggest the accounting body is walking back from strict fair-value interpretations.

In particular, he says a December amendment to FAS 107, which mandates disclosures of financial instruments, now allows corporations to reveal not only the fair value of the assets, but also the expected cash flows from their assets. In the current environment, this could allow companies to show higher valuations than the market is signaling.

"There's no question they're backing off from a strict mark-to-market application," Willens says, although he doesn't expect the accounting board to repudiate its application of the standard. Rather, he argues, the board will keep amending it, allowing managers and auditors greater flexibility in how to apply the market standard.

"It's a face-saving thing."

Whether auditors or accountants agree to any easier application of fair-value rules, however, is another question. Oaktree's Marks says auditors have taken a hard line since Enron Corp. went bankrupt and its managers were implicated in accounting fraud. This, he says, has made auditors look askance at attempts to apply subtlety to interpretations of balance sheets. "Your subtlety is my subjectivity and someone else's wiggle room," he says.

There is great irony, however, in Enron influencing auditors to take a hard line in interpreting fair-value measurements. After all, the company benefited from a 1992 SEC ruling that allowed it to use mark-to-market accounting to value its long-term gas and derivatives contracts. This ultimately allowed Enron to overstate its earnings for years and eventually helped produce the company's collapse.

Charles Niemeier, former chief accountant at the SEC and a member of the Public Company Accounting Oversight Board, put it this way in a speech delivered in December 2004: "The most disturbing aspect of Enron and similar scandals was not what was done that was wrong, but what was done that was right. Enron did not ignore the rules and regulations, but instead it took them and used them to achieve results that were never intended."

Right. Wrong. Benefit or bane. Objective versus relative standards. The market or the regulators. These are fundamental differences. And because of them, the now venerable debate over how to account for financial assets does not appear to be fated for resolution anytime soon. Too bad.

Another Rollar Coaster Day

If you are pining for a simple-to-trade, easy-to-understand market, keep hoping. We had quite a chaotic day with an ugly spike down even though AAPL had a great report last night. We sunk steadily but rallied back above our opening levels for no apparent reason around midday before the traditional jig in the final hour.

While the indices finished solidly in the red, they were not as bad as breadth would indicate. We only had about 1,375 gainers to 4,450 decliners today. Precious metals were the only major group in the green due to some movement in the currency markets. The volatility was mostly a function of financials, which still look terrible overall but managed to jerk things around quite nicely.

GOOG earnings are out and look at first like a "beat." This may be enough for the market at the moment. The stock is up a bit but there doesn't seem to be a high level of excitement. COF also posted terrible earnings, but the stock isn't reacting much, which tells us that no one expected much.

Tomorrow morning is the GE report, which should generate a reaction and influence the financials. The financial sector is a complete mess but as we saw the last couple days, the group can really move the market if the traders jump in. Remember when double-digit declines in the likes of C or BAC would cause panic amongst traders? No more.

The big technical picture is murky at best. While we are still flirting with breaking the December support levels, we are holding above them. That may be enough for now and may even support a decent bounce, but this is a not a particularly pretty picture.

Wednesday, January 21, 2009

Shorts Squeezed In Financials Today

This morning's rather weak bounce turned into a big short squeeze of financials in the afternoon. Some inside buying at BAC and a big reversal in USB sparked the group and sent the shorts to the sidelines and the momentum players chasing.

As the day progressed, energy and commodity-related stocks heated up as market players sought out exposure that wasn't quite as volatile as the financials and maybe had some better fundamentals.

Volume was a bit light but breadth wasn't too bad. However, given the extent to which we have been hit lately, the action probably still isn't much more than just a decent oversold bounce.

I'm certainly not convinced that financials are out of the woods, but the immediate issue for the market will be earnings from the likes of AAPL, GOOG and MSFT. The reaction to those reports is going to determine if this bounce has much more life to it.

We are beaten down enough and expectations are low enough that buyers are likely to be lurking about. The bigger picture is still iffy of course, but given the strength today it's obvious there is some desire to get busier on the long side.

'Phantom Jobs' Are Not So Illusionary After All

According to the top bloggers, prominent writers for major financial publications and some leading market strategists and economists, new businesses cannot be created in a recession. Pundits call these "phantom jobs." However, this can be easily disproven through an examination of the data.

Analyzing the labor market is not so different from analyzing the stock market. When the market moves lower, the pundits say, "There were no buyers," while on strong days they say, "There were no sellers." That's shorthand for "every trade has two sides": There is a buyer for every seller. On down days this means that the demand curve for stocks shifted and the clearing price is lower than before.

The economic system is dynamic -- we do not try to trace the effect on individual buyers and sellers. Instead, we look at the overall market effect. But instead of considering employment as a dynamic system -- where there are always businesses closing and starting and jobs are gained and lost -- market experts look at employment by focusing upon traceable and visible effects.

When jobs are lost, there are continuous trumpeted news announcements about layoffs: 15,000 here, 25,000 there. Job gains do not generate any announcements, however, mainly because they are in small increments in both existing and new businesses. The monthly payroll employment report shows the net change in jobs without giving a sense of the underlying dynamics. This results in most observers concluding that there is no hiring and no new business creation.

This widespread and seriously mistaken viewpoint also causes skepticism about government efforts to measure job creation. This attitude does not begin with data but emotion, and it has fostered a multiyear attack on the U.S. Bureau of Labor Statistics' (BLS) effort to measure accurately the change in employment.

The series on business dynamics started in 2002, but the reports extend back to prior years. The data are not from surveys, but state employment data. Since no one reports employment or pays taxes on phantom jobs, these are data that we should believe.

Data from 2001, the most recent recession year, show nearly 3 million jobs were lost during the year. This is a net result, subtracting jobs lost from jobs added, which were both over 30 million. However, more than 7 million jobs were actually added in opening establishments. In some quarters, there were actually net jobs added from new establishments, the difference between business births and deaths.

There is always job creation thanks to the invisible hand of the market. Sometimes unemployed workers are available to new businesses, which are always forming and are quite significant when people lose other jobs. This is occurring in the current economy: The market fixation on the widely publicized layoffs ignores new job formation. These jobs are the ones that come naturally from new, inexpensive resources, and potentially from the stimulus package.

Understanding labor dynamics is crucial in interpreting economic news, and will be pertinent in evaluating Obama's economic policies and the stimulus package.

Tuesday, January 20, 2009

More On The Crash In The Banking Index - Banks Are In Fact Hoarding Cash

Commercial banks continued to hoard cash in the week
ended Jan. 7, according to new data released late Friday
by the Federal Reserve. Cash assets held by commercial
banks have increased massively since August, from a
steady $300 billion from months on end to a record
$1.090 trillion last week. Last week's increase was
$125 billion, which followed a decrease of $81 billion
the previous week.

Cash balances have increased as a result of the Federal
Reserve's massive liquidity injections, for example the
Fed's purchase of commercial paper. Cash levels have
increased also because of injections of capital by the
U.S. government via the TARP.

Bank assets are now $12.297 trillion, $1.1 trillion more
than in August. Hence, most of the increase in bank
assets has been from the increase in cash holdings.
Loans and leases have also expanded since August, but
by a much smaller $166 billion, to $7.133 trillion. The
$166 billion increase breaks down as follows: $51
billion for commercial & industrial loans; $37 billion
for consumer loans; $125 billion for real estate loans;
$22 billion for other loans and leases; -$69 billion for
loans to purchase securities, reflecting the deleveraging
of financial firms and the smaller trading positions
they now hold.

At some point the Federal Reserve will find the "right"
number -- the amount of excess cash that compels banks
to lend -- but it has not yet found that number, judging
by the cash hoarding that has occurred and the small
amount of lending seen by comparison, although some will
be surprised to hear that there has been any lending at

No Obama Bounce, In Fact, A Crash In The Bank Index

I suspect that there were some folks who were hopeful that excitement over the Obama ascendancy to president might spark a little buying interest. I certainly did not expect a 20% drop in the banking index, even with the news out of Britain. Unfortunately, the banking sector practically collapsed today with stocks like RBS, State Street, Citigroup and Bank of America acting like they were on the fast track to zero.

Without better action in financials, the market had no chance today. Breadth was horrible with only gold attracting any buyers and we did some technical damage as well by taking out the December lows on the senior indices. We couldn't even manage more than a minor, short-lived bounce in the final hour and ended up closing at the lows.

So far, 2009 marks the worst start ever for the market and it's a bit unsettling that the high hopes for the Obama presidency have not given this market any real boost at all. He is promising some real change and I think he means it, but this market isn't buying it. Obviously market players want to see some results and not just rhetoric. Until we actually see banks find a floor there will be no confidence among investors.

More than anything, we need confidence and certainty. That means some positive results and that is going to take time. Welcome to the presidency, Mr. Obama. You have your work cut out for you, but (hopefully) we are all rooting for you.

Friday, January 16, 2009

We Got The Positive Day That Was Needed

We needed a positive day following the intraday reversal yesterday for a positive technical setup. We ended up with one and, maybe due to option pressure, the S&P 500 ended up right at 850, which is a key technical level. The Nasdaq also closed right near a key level around 1,530, which is the 50-day simple moving average.

At midday, it looked like this market was all set to roll over, but some positive news from Barclays rallied European banks. We probably had some short covering in front of the long weekend and the Obama inauguration next week, and of course option expiration contributed to some pushing and shoving. With the European and Asian markets open on Monday, there is some added risk to holding and that may have influenced trading.

Even though the major indices finished in the green, the weak action in major banks including BAC, C and JPM is quite troublesome. This market is not going to go a whole lot more to the upside until the major financials find their footing. The way they are acting now, it sure SEEMS like there is another shoe to drop.

The bulls will have their work cut out for them when we come back to work on Tuesday, but the close today gave them a leg up. They are going to face some technical hurdles quickly, but it will be up to the banks to determine if they can build on this bounce much further.

Enjoy the long weekend!

Thursday, January 15, 2009

Comeback Market - The Dive That Didn't Happen

It was not a stunningly positive day but a pretty good comeback from being stretched too far to the downside. The banks are obviously a problem and they are going to keep us contained as long as they have such major unresolved problems.

Even though banks were weak again today as BAC looks for additional TARP funds, traders did see their oversold bounce. Although the S&P500 and DJIA were close to flat, they were well off their intraday lows. Technology stocks led the charge with some help from retailers.

The very pitiful-looking C has earnings in the morning and obviously there isn't anything positive being expected. Unfortunately these bank stocks are not finding a bottom and that is the biggest weight on this market.

INTC earnings are out and appear to be in line. The first reaction is slightly negative as the company is not providing guidance due to economic uncertainty and limited visibility. There is nothing too surprising but it isn't something that is going to entice a lot of buying.

We are still oversold enough to support more of a bounce, but the financials will be the key to whether we can get much going.

Series - Valuing Stocks

A signal that a company's earnings deserve a closer look: Rising cash sales and a cash margin rate that is falling. Cash sales = revenue - increase in a/r. Cash margin = subtract from cash sales the sum of cogs and the increase in inventory, and divide the result by cash sales. A confluence of these 2 trends could mean the company is extending credit to customers to make sales and building excess inventory. Enron showed this in 2000; Cisco also did it and took a huge inventory write-down later.

Wednesday, January 14, 2009

Yet Another Horrible Options-Week Wednesday

In the words of the great Jed Clampett, "Wheeeew doggies!" That was ugly.

Breadth was horrendous with only 831 gainers to 4082 decliners, the point loss was big and the flight back to bonds resumed. We continue to see relatively light volume, but that really isn't much comfort. Also we are barely propping up the support levels formed in late December, but it sure doesn't look like there is any rush to jump in and buy this market.

Conditions are improving for some sort of snapback attempt. With earnings from JP Morgan tomorrow morning, and Intel Thursday night and Citigroup on Friday morning, we will have some potential news catalyst to move things around. Expectations are obviously extremely low, but with the relentlessly negative news flow, buyers are just standing aside. Until we either get some good news or buyers start ignoring the bad news, we can't expect much upside traction.

The really sad thing about this market is that so many folks were thinking it couldn't be any worse this year than it was 2008. So far we are doing even worse than the terrible start of a year ago. I'm sure some hopeful folks are off to a bad start and that is not going to do anything to help this rotten sentiment.

Tuesday, January 13, 2009

Hopefully Lowered Expectations Will Work Its Magic

The most interesting aspect of this market now is how completely negative the news flow has been. We have had nothing to excite investors lately other than the hope that expectations are low enough that more bad news will be shrugged off.

Technically, the major indices are holding above the late December lows, which is a positive, but it is obvious there isn't a high level of confidence that they will not be breached at some point.

Given that we are still technically OK, and despite the high level of gloom and the low expectations, I'm bullish for an upside trade in the near term. We need some sort of news catalyst and it may be in the form of bad earnings news that is well anticipated.

Two stocks held back the market today: General Electric and Bank of America. Without them, the bulls probably could have gained some traction.

Even with the weakness in those key financials, it wasn't that bad of a day. It was quite choppy once again and we swung around in the last hour and a half, but breadth was positive at about 3,150 to 2,650 and almost all the major sectors were up except for solar energy.

This certainly is not a healthy-looking market for the moment, but we are due for some sort of relief bounce here soon. I know at some point we are going to see a decent bear market rally.

Monday, January 12, 2009

A Light Volume Day Can Certainly Be Ugly

Aside from another little flurry of trading action in the closing minutes, it was a downright ugly day. Yes, volume was light, but I'm afraid that may be a function of little new money coming into the market and may not be that much of a positive. Unfortunately, lower volume may mean we are losing participants rather than just folks sitting on the sidelines. There is no way to know for sure, but this light volume is not something giving me a lot of comfort.

We are still holding some key technical support levels and have gotten a bit oversold now, but the danger of breaking lower is growing. We may see a little bounce first, but earnings season could easily be the catalyst that causes the last support levels to hold. The November lows are still quite a ways off, and we'll be way too oversold to hit them quickly, but the lows of December could easily be breached in the near term.

This market was much worse today than it looked, especially the way financials broke down. The big banks are low-priced, and therefore the big losses were not reflected in the Dow Jones Industrial Average.

I really wish the media would stop using the DJIA as the primary indicator for the stock market. They way it is calculated, it assumes that you are not holding an equal amount of each stock in the index but that you hold widely different size positions based solely on price levels.

For example, at current prices the DJIA assumes that you hold 15 times more IBM (IBM) than Citigroup (C) , because IBM is $85 and Citibank is $5.60. Thus, on a day like today when Citi is down 17%, the impact isn't that great, because it is mostly offset by a gain in IBM of 1% or so. That is not how a normal portfolio is generally constructed, so the DJIA isn't really reflective of anything meaningful.

Nonetheless, it is just plain ugly out there, however we are a bit oversold, if that's any comfort.

Friday, January 9, 2009

Still Mostly That Confounding Random Action

On Thursday a lot of folks where looking for a rally to occur after the jobs report was issued this morning. Many didn't even think the level of the numbers mattered that much. The logic was that the worst was already baked in, so the buyers would quickly jump in on some weakness. Given the recent price action, that didn't look like too bad of a bet.

The jobs report turned out to be pretty close to expectations and, to the surprise of many, the immediate reaction of the market was to do nothing. When the bulls realized that there was no one jumping in to push us up, they hit the exits, and we went straight down in the first 30 minutes of trading.

After that, we meandered about until the typical final-hour spike-fest, which jerked things up, down and all over the place. This last-hour stuff is just totally random as traders push things around, and it makes holding positions extremely tough.

On a bigger scale, the major problem this market is dealing with is trying to figure out whether we really have priced in all the bad news out there. Investors want to believe that we have, but when you really delve into some of the details of things like the unemployment rate, it is awfully tough to imagine a quick and easy economic recovery.

In addition, we have earnings coming up, and analysts have been very busy downgrading things before they hit. Expectations are going down, but we don't know if they are going to be low enough.

The choppy action and confused investors are keeping this market very difficult. The technical patterns are still OK, but they are eroding, and we need some strong buying conviction pretty soon if we are going to manage any sort of bear market rally.

Thursday, January 8, 2009

Calm Before Friday's (Employment) Storm?

Despite some ugly chain store sales numbers, multiple earnings warnings (particularly from WMT), a handful of earnings misses and a few earnings misses, a late-day recovery allowed the major indices to finish well off the lows of the day in mixed territory. Instead of being set up for a “buy the bad news” response like we got last month, we’re facing a possible “sell the news” reaction to the data tomorrow morning. We’ll see how it goes, but one thing’s for sure: trying to anticipate how market players are going to react remains as difficult as ever. Given how they acted into the close, they may even be ready to buy, no matter what the data looks like in the morning.

Regardless, today’s action keeps the major indices in decent technical shape, but no less difficult to trade. I still like AOD, especially when the NAV dips into the discount realm.

Long: AOD

Wednesday, January 7, 2009

Rain Washed Out The Picnic

As is so often the case when folks are getting downright giddy over how the market is acting, we have a particularly ugly day. Volume could have been heavier, but otherwise there weren't many bright spots to be found. Breadth was terrible, with all major sectors down and the Dow Jones is almost exactly flat for the year after a strong start.

The indices were short-term overbought and then we had some bad news from Intel and Alcoa to spark the selling. When the dip buyers failed to gain upside traction intraday, the sellers took control and kept the pressure on. There was a late bounce once again to take us off the lows, but we still ended up with decent point losses.

Even with the loss today, we haven't done any great technical damage to the base that has been forming for the last five weeks or so. In fact, a pullback here is really what we need but holding support is the key. The buyers need to step up fairly soon or we risk some real trouble.

Tuesday, January 6, 2009

The Market Has Strength Under The Surface

The major indices were quite chaotic today but managed some good gains. Under the surface, it was stronger than it looked, with breadth running extremely strong. We ended up with about three gainers for every loser, and there were a lot of big "junk off the bottom" movers, particularly in some of the technology names we haven't heard about in a long time.

We closed weak, and there were some intraday reversals in the energy and commodity names that have been leading. There obviously is some underlying speculative action as folks are anxious to kick off the new year on a positive note.

The true test of the character of this market won't come until we have a pullback. So far we've have had some great underlying support on the minor pullbacks. That is probably due to anxiety about underperforming in the first few days of 2009. As that psychology subsides, we will see if there really are value buyers lurking out there.

Earnings season is also coming up soon, and the psychology that develops as reports hit is going to determine the next move in this market. At the moment, we seem to be rather sanguine about the continued bad economic news, but at some point we will really need some improvement in conditions.

yes, jobs' health is a concern; but buy aapl anyway

aapl traded lower on macworld machinations as well as lower itunes pricing. i think the market is thinking too much about 20 cents a song and not thinking enough about how much imac and macbook market share is going increase in the next couple years, or the fact that that all the iphone nay saying has been blown out of the water.

one interesting tidbit is that no one has mentioned how disgruntled many loyal msft office users are with the new release. and from my personal experience of the new office i would give it a "d" at best. i have felt over the years that office was one of the greatest software productivity tools of our generation. those days appear to be over now.

at this point you could run a good sized company with mac's, goog docs or open office org, and linux. and more companies are evaluating these choices every day.

bottom line, i see aapl approaching 10% computing share and you won't see the stock trade under $175 for quite some time. so i'm starting to build my position tomorrow, hopefully around 92 or 93.

Monday, January 5, 2009

Profit-Taking Overcomes Santa - But Turnaround Tuesday Tomorrow?

After the Santa Claus rally over the last three trading days, we were due for some profit-taking. It hit today but overall it was fairly mild. Breadth on the Nasdaq was just slightly negative and energy and commodity stocks continued to be chased higher. Financials were weak today and JPM in particular looks precarious, but overall it wasn't bad action.

The question we have to ponder at this point is whether the end of seasonal positives are going to cause some flipping and more aggressive selling. We had a big run and there are some recent gains to protect. This was a fairly classic end-of-the-year run and traders were obviously hungry for this type of action, but one thing we learned last year was to take profits when we have them.

We still have solid technical setups for the major indices in the intermediate term, but we are extended shorter term and the test will be how we act on a pullback. Are the buyers who missed out on the recent move going to jump in on weakness or will selling accelerate? Is the upcoming earnings season going to throw some cold water on the mood or will investors be buying the bad news?

I suspect the bears are going to start looking harder for some short entries here. The bulls have the advantage, but it's possible lots of folks are going to be looking to cut back on longs here very soon.

will the yield curve steepen in 2009?

the massive amount of bond issuance will most likely put pressure on the long end of the yield curve. this means we should see a further steepening of the yield curve in 2009, but it will not necessarily point to a big economic recovery like it has in the past.

typically, a steep yield curve encourages banks to lend and pick up the yield spread. this usually generates economic activity. as an example, in the early 1990s the spread between the two-year treasury note and ten-year treasury note moved up to 250 basis points and led to a recovery in the housing market. this may not happen this time 'round as the economy is deflating and the risks to new, unforced (nonrevolver) lending are high, making banks cautious.

this is most likely why, with the significant increase in money supply, there has not been a positive influence (yet) on the economy. the velocity of $ has shrunk as money has been parked in money-market accounts. this further extends the spread between the 2 and 10 year treasuries and should steepen the curve.

my prediction? given what i just wrote above, i think things basically play out as they did in the early 90s. banks will pick up the yield spread eventually.

how much liquidity has been pumped into the system?

according to bianco research, here are a few examples of historical us government expenditures (in inflation-adjusted terms):

marshall plan - 116 billion
louisiana purchase - 217 billion
race to the moon - 237 billion
s and l crisis - 256 billion
korean war - 454 billion
the new deal - 600 billion
gulf war 2/war on terror - 625 billion
vietnam war - 700 billion
nasa - 850 billion

Friday, January 2, 2009

A Good Day To Start The Year

It was obviously a very good day for the overall market. The point gain was big, breadth extremely strong, and a lot of stocks were up by huge amounts. Quick flipping has been the best approach to this market for quite a while, but if you have taken that approach the last few days, you found yourself on the sidelines as some groups such as bulk shipping, infrastructure, steel and oil kept running straight up. The nature of what works best in the market changes all the time, so we need to constantly adapt if we want to perform well. At times it is very hard to do that as quickly as you should, and sometimes you will simply by left on the sidelines.

I came into the day expecting it be fairly quiet. For some reason I don't think that today is going to be our last chance to ever buy stocks. In the bigger scheme of things, this is technically positive, even if you weren't fully invested to enjoy it. The charts have been looking much better, and the key now will be that dip-buyers emerge on pullbacks. Assuming of course that we ever pull back again, which apparently is questionable in the minds of some of the buyers today.

Thoughts At The Open

One of the best things about the stock market is that, at any time, investors have the opportunity to start fresh. The beginning of a new year provides a logical point where we an think about how we want to approach the market. One of the worst years in stock market history is behind us, and now is a good a time as ever to focus on having the proper mindset to stay flexible and react to the action as it develops.

There's no shortage of folks out there who are more than willing to let us know exactly how the action will play out over the course of the next twelve months, exactly when the economy is going to recover, and what stocks we need to be buying so that we too can be fully invested for the next great bull market that is surely getting ready to begin. Although it’s impossible to avoid having feelings about how things are going to play out, locking yourself into any rigid view robs you of your unique and powerful strengths as an individual investor. It doesn’t matter is you think that we’ve already begun the next primary uptrend, if you think the bear is going to start growling again, or if you think that we’re going to see the action punctuated by strong rallies and gut-wrenching disappointments. The thing that matters is that you are open-minded and are psychologically prepared to adjust your approach as conditions change.

So, with that in mind, let’s talk a bit about where we stand right now. Although the market was unable to make much progress after the strong start to December, we finally had some good holiday-style trading to end out the year. Volume was light and there’s no doubt that a lot of that was influenced by a heavy dose of window dressing, but it did allow the major indices to move back above their respective 50 day moving averages. Moreover, the fact that the broader market has been able to hold in a decent trading range near recent highs has also provided a foundation from which several individual charts have been able to develop decent technical set-ups.

In the near-term, with the indices again bumping up against short-term lateral resistance, it’s a stretch to think that we are simply going to rocket higher from here. However, new money flows into the market at the beginning of the year, so we still have some positive seasonal factors at work, and the market is at least in a position where we could see some further progress to the upside.

At the same time, we are still suffering from a lack of confidence, an absence of leadership, and the ever present specter of volatility. Forgetting for a moment the unpredictable nature of newsflow, those are the factors we need to be watching very closely. We need to look for groups that are seeing good technical progress as a whole, for investors to stop flipping as soon as they see the slightest of gains and for these wild swings to calm down – especially in the final hour.