Monday, September 14, 2009

And Now Back to the Stock Market

It has been some time since a comment on the stock market and the state of the economy.

On the surface to many, including CNBC-type pundits and others with professional self-interest, most appears well in the stock market. We've experienced about a 50-percent move up since the March lows, with many stocks far exceeding that. Also on the surface to many, all appears to be on the mend in banking and even in housing in certain regions of the nation. Recent surveys show improvements in consumer confidence and yes, even manufacturing activity. Honestly, I forgot that we manufactured anything here except bad mortgages and creatively packaged financial derivatives products.

The next "big thing" is apparently going to be chopped and repackaged life insurance policies. Talk about "death panels!" We don't want the gubbamint doin' death panels. But hey Wall Street? Just fine with us!

Back to the real subject, though. We live in a consumer-driven economy. Our wallets and credit cards account for something like 70-percent of economic activity in the United States. And no, it is not all accounted for by the wealthiest two-percent. Sorry folks. This pundit does not think that they need even more unaffordable tax cuts, as much as some Republican politicians and pundits might have us believe that is the route to follow.

I could use a tax cut though. How about you? When I see my health insurance premiums increase nine-percent or so in 2010, and my income stagnate, I suspect I will be spending less - again! - or relying on credit cards to fill my material desires. But since people continue to express concern about job security, will they really ring the registers? Perhaps for Christmas. Maybe not. Too early to say, in my opinion, though spending addicts may say, "What the heck" by the time December comes around.

The recovery in the stock market is not unprecedented. However, it feels - and in some ways looks - like it is built on beach sand and not bedrock. To the extent that we are seeing earnings growth - the "bedrock" of the stock market - well it's largely a result of "downsizing." Hey that's you, isn't it! You may be among the millions of people that have lost their jobs over the past year or so, not to mention the millions that lost their jobs during George W. Bush's stewardship of the economy.

Given soft demand for goods and services - slow or no revenue growth - what better way to prop up profits than to fire the people....hmmmmm....that BUY YOUR STUFF. Oh sure, you can have your business rely on the federal government for incentives and bailouts. Worked for a month or so for the auto industry with "cash for clunkers." It's also working for banks, especially the largest banks, you know, the "too big to fail" banks that still plague us.

Remember all the bank and Wall Street "stuff" that precipitated the worst recession since the 1930s? Mortgage-backed securities and derivatives and such? To a great extent, they are still on the books of the largest financial institutions in the nation. Only now, we don't seem to be worrying what they are worth because the feds changed the rules - well at least for a period. With all the foreclosed properties clogging the housing market and with all the potential for millions more down the road, who cares how much those mortgage-backed securities are really worth! Especially since housing prices are predicted to continue to fall in many regions of the country.

Oh, almost forgot. Commercial mortgages and construction loans. With retailers and others continuing to "downsize" and close locations, with corporations consolidating office space and continuing, yes, to ship manufacturing overseas - well we'd rather support a Chinese worker than an American one, being the patriotic Republicans and business managers that many are - what about those loans?

Wall Street must be onto something. Bundling life insurance policies! After all, you recall - or do you - those stories about investment bankers jumping out of buildings during the Great Depression, right? Maybe this economy will slash average life expectancy and those chopped and bundled life insurance policies will pay off handsomely. Who needs jobs? We don't need to build things; we can just kill people off by keeping conditions bad.

But then, we'll have to worry about the actuarial integrity of life insurance companies. I hope they have sufficient reserves to pay everyone off.

Oh yes, the stock market. I got sidetracked worrying about PEOPLE'S JOBS and stuff like that.

I maintain that it is still a challenge to value many companies based on projected earnings because I still see too many uncertainties in the economy. So I must keep a sharp eye on those pesky technical indicators of stock market strength. And they are truly a mixed bag.

A couple of things stick out, though. First, the good old Advance/Decline line. What's that? (# of Advancing Stocks - # of Declining Stocks) + Previous Day's A/D Line Value. It's a cumulative thing. It has been climbing a very steep wall since the March bottom. In fact, it is at its highest value in history, near as I can tell. Looks like a good thing. Investors are accumulating stocks - at least more are increasing in price every day. But the climb seems unprecedented in its scope and time. And it is not like we've been experiencing record volume, day in and day out, to support this advance. Lots of cash remains on the sidelines, in safe havens.

Second, all analysts have their favorite short- and long-term trend lines of the popular stock market indices. I have mine, but you don't need to know what it is just now. In any event, having absolutely nothing else to do with my time, I spent a few moments to go back in time, oh a little more than two decades. Helps to put these trends in perspective.

When the stock market climbs too far too fast, like anything else the law of gravity tends to bring it back down. No, not necessarily back to wear it started, but usually to the soft, warm, cushy support of one or more coveted trend lines.

In our current scenario, the stock market is about 15-percent above trend line. Historically speaking, this is pretty high. In fact, we don't often see the stock market double-digit percentages above this trend line. Going back to, say, 1987, we've seen this about six other times. On average, the stock market has pulled back about nine-percent each time. I tossed out the two outliers of three-percent and 55-percent that began in February 1996 and August 1987, respectively.

True, only two of these declines represented double-digit percentage declines - the 55-percent bubble of 1987 and 18-percent in 1997. The others? "Small potatoes."

So what might we be looking at here? Well, case #1: the stock market falls out of bed and either erases all of its gains since March, or perhaps a third of them or thereabouts. Case #2: not much in percentage decline, but months of treading water, perhaps after an initial decline in the ten-percent neighborhood.

This market is fragile, as is the underlying economy. Without improving prospects for job creation, increasing personal incomes, and stability in housing, unless the United States suddenly becomes a ginormous engine of exports to the rest of the struggling world, a flat U.S. economy will eventually translate into flat stock market prospects, and it is more than likely to begin with at least a small thud.

The slightest disappointment, out of Washington or elsewhere, or perhaps it could be a big disappointment, like, oh for instance how are independent auditors going to do with all those possibly nearly worthless toxic assets on the books of financial institutions at year-end audit time? Can't hide them in plain sight forever, can they?

Citi, JPMorgan Chase, Morgan Stanley, Bank of America, AIG, and lots of small little known banks and other players, are still - pardon my street lingo - full of crap. Answer me this: to the extent that you have not written off billions of dollars of paper whose underlying assets are defaulted mortgages on now or soon to be foreclosed homes and businesses, well just how do you plan to handle that? How do you place a value on non-recyclable trash?

I can't offer up a day or value for this stock market's top. Could the S&P500 advance another 100 points? Sure, why not. But at this point, unless we begin to see some solid fundamental improvement in the economy and not simply a deceleration of its decline, the higher we go from here, the bigger the fall will be. It's gravity.