A FEW THOUGHTS ON YESTERDAY’S RALLY
Yesterday’s market action was anything but normal and likely driven by massive short covering and unbridled optimism (read, confusion) over the state of the U.S. economy. There was no real positive news. In fact, the news of the day was that CIT was on the brink of failure. That news would have sent the market over a cliff 6 months ago, but optimism has kicked pessimism down the stairs – for the time being. David Rosenberg points out that the rally was built on nothing more than Meredith Whitney’s commentary, which was actually an overall bearish call and a company specific bullish call:
We thought that the ability of one person to move the market went out three decades ago with Henry Kaufmann over at Salomon Bros., but Meredith Whitney did manage to do the same — in a bullish fashion, though — with her CNBC remarks on Goldman yesterday morning. (Although, it was interesting that Dell’s reduced guidance for the current quarter garnered little attention.) What was interesting was how she stressed that this was not an industry-wide comment but rather specific to the firm and yet this was the tide that lifted all boats across the financials and the entire stock market for that matter. What this tells us is that even after 12 years of no appreciation in equities, and after brutal bear markets seven years apart, the public’s resolve in the stock market has not been shaken. The fact that the equity market could rally this much based on one analyst’s commentary is testament to the view of how badly investors want to believe that the recession and credit crunch are behind us and that unbridled prosperity lies ahead. As WTO Director-General Pascal Lamy said yesterday, “I would caution against excessive optimism.”
What’s more worrisome is that investors are bidding up stocks in anticipation of “better than expected” earnings. Regular readers know that I became increasingly concerned about earnings as the official start of the season approached. I knew the banks would generate better than expected reports and wouldn’t dampen the party with their guidance since banks don’t provide guidance. It was the deciding factor in my move from a bearish stance established at S&P 945 to a neutral stance at S&P 890. The real problem, though, is that the underlying earnings are not nearly as strong as the bottom line might imply. Revenues are still deteriorating at a furious pace. The only thing keeping the bottom line from plummeting is the unsustainable cost cuts across the board.
So what are the implications? As I mentioned, the banks always lead off earnings season, but they don’t give guidance. Don’t be shocked when we get more results like Goldman’s although not nearly as strong. But don’t be fooled. Anyone who believes the U.S. banking system has been cured is a fool. The banking system will be crippled for years by these asset impairments and change in business model. The 90’s are not coming back (unless you’re Goldman Sachs and you press on the risk accelerator like it’s going out of style). I believe the market can continue to rally as the banks release reports, however, once we get into the thick of earnings season and we get numbers from the retailers and materials firms the true weakness in the economy will once again begin to show. I believe the market is placing a short-term trade on fundamental drivers that are questionable at best. Don’t be shocked if this market were to roll over like a well trained dog as we get deeper into the earnings season. For now, the trick to buying stocks is to be the guy/girl who is NOT holding the bag at the end of the day – for that day is coming.
……it is so much more difficult to lie about “revenues”, ie, sales/income than it is to lie about “earnings”…….and the top line continues to drop and drop….they can manipulate their earnings a hundred different ways….but “sales”, well not so much…………
One thing to keep in mind about bank earnings is that the accounting rules for banks have been recently changed in a way that allows the banks to hide and delay the reporting of their losses. It was immediately after this accounting change that the big banks all of a sudden became a lot more profitable than before.
I’m a little surprised that so many investors are so gullible as to believe and buy such an obvious trick. Hiding losses doesn’t make them go away. Sooner or later some of these big banks will need to be rescued by the government again.
Which is why I’m so sure that this is a bear market rally and not a new bull market. When investors are so easily tricked and deceived. Then the prices they pay for stocks most likely are based on fantasy and not on reality. And reality has a way of making itself known sooner or later.
Which is why I’m so sure that this is a bear market rally and not a new bull market.
I’m of the opinion that falling into the bull vs. bear dichotomy is a mistake. This may be something entirely different, which would defy both camps.
My working theory is that the market deservedly corrected from the absurdly high Dow 14k level, which was a fully levered speculative level. It should have probably ended up somewhere in the 9-10ish range, but then drastically overcorrected and remained overcorrected due to some rather specific news events (Lehman, GM, AIG and Geithner’s unfortunate comments re: the dollar’s reserve status), which coupled with massive deleveraging to create exceptionally high and unwarranted swings. We are currently in the process of fixing this overcorrection, working our way gradually back to the levels where it should have fallen in the first place. Repairing a hole that should have never been dug is a move that is neither bullish nor bearish at its core.
Meanwhile, treasury returns are exceptionally low, commodities have probably been bid up excessively, and real estate remains scary, which leaves equities as one of the better categories left standing. Companies are doing a decent job of turning their unemployment into profits and efficiency gains, and have positioned themselves to be more profitable when customers come back.
All told, that signals to me a market that may run up a bit more from here before going flat, leading to a jobless recovery with sloppy trading and generally low returns on just about everything. In that environment, a few select individual stocks and sectors will beat indexes, and corporate bonds may well be more attractive in many cases than stocks.
There is plenty of room for bad news or for gaming this incorrectly, so caution is warranted, but I would expect some positives earnings surprises and decent numbers to bring a bit of a relief rally. But overall, this is not a time for either strong bullishness or bearishness, so much as it is a return to normalcy.
So MBA,
How are we supposed to invest now if we don’t have a directional bias?
Nick, while the accounting verbiage was slightly changed with FSP 157-4, the rules in fact were not. There has been no appreciable change in the accounting or recognition of losses, and this is born out in the 10-Qs of nearly every company (financial or otherwise), with the exception of one Wells Fargo, who benefited from a $4B revaluation. I think that tells you more about WFC than it does about the rest of the banks. The fair value story is a red herring from every conceivable angle.
How are we supposed to invest now if we don’t have a directional bias?
That’s the point — don’t married to a rigid directional bias that could get you killed. There’s something to be said for neutrality at times like this.
I’m cautiously slightly bullish myself, given that I expect a pretty good earnings season. But I have no high expectations for either a huge sustained upswing or a profound crash, and I can see numerous reasons that the gain that I’m expecting may not materialize. The permabear mindset has attracted an online fan base, but I’m not joining that club, either.
There are times when you just need to admit that you just don’t know. Clearly, the bears have missed the boat during the last few months, so I wouldn’t be running to them for guidance on short-term trades. There are occasions when trends are so clear that they are unmistakable for those who are observant, but now there is plenty of ambiguity and room for doubt. I’m inclined to be short long-term treasuries and long on select financials myself, but aside from that, I personally have few strong convictions.
MBA,
I completely agree….
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