FUNDMENTALS DON’T MATTER UNTIL THEY DO

By Comstock Partners:

The market rallied when the FOMC said it would keep the Fed Funds rate at current levels for an extended period just as it rallied when it became likely that the EU would paper over (at least temporarily) the Greek financial crisis.  The market apparently continues to have great faith that the various central banks throughout the globe will continue to bailout and guarantee that they would never let any entity fail and would assure continued economic growth indefinitely.  In other words, what economists and strategists used to refer to as the “Greenspan put” has now essentially become the “Bernanke put”.   We at Comstock have no such conviction that piles of additional debt issued or assumed by governments can cure the problems that were brought on by too much debt in the first place.

In this connection the delusions and hopes associated with the current rally bear a lot of resemblance to the unwillingness of investors to recognize reality at the market tops of March 2000 and October 2007.  In the late 1990s and into early 2000 the market gave enormous valuations to tech stocks with no earnings and, in many instances, little or no sales as thousands of people with no market experience spent their time day trading their way to huge profits that evaporated, along with their initial capital, in the ensuing market carnage.

When the game ended with big losses and a potentially deep recession, the Fed stepped in by keeping interest rates at 1% for an extended period and encouraging, along with others, a massive boom in housing.  Despite warnings by reputable individuals such as Paul Volcker and by institutions such as the IMF and the World Bank, the stock market soared.

Even when the dangers of the housing boom started to become evident in the media and the industry began to weaken, the stock market surge continued unimpeded.  In August 2006 an article in Barron’s described in detail the number of new mortgages and home-equity loans that were interest-only, no-money-down and adjustable-rate. Other articles explained so-called “liar loans” whereby purchasers were able to get mortgages with no documentation of income or assets.  In the same period various mortgage lenders went public with their dire problems.  These companies included, among others, H&R Block, Impac Mortgag, Countrywide, Accredited Home Lenders and Washington Mutual.  During the following period revelations came out almost daily how mortgages were packaged and sold, sliced and diced and distributed all over the globe.  In June 2007 two big Bear Stearns hedge funds came close to collapse and still Wall Street didn’t get it.  The stock market kept rising into October as investors belittled the importance of subprime mortgages, and, in any event, assumed the Fed would take care of everything.

Now, once again the markets are assuming that central banks around the world will save the economy despite the severe problems that are known to all and despite the fact that the S&P 500 has already experienced two declines of more than 50% within the same decade.  The economic recovery remains extremely weak, plagued by consumer deleveraging, a weak labor market, tight credit, a hidden inventory of homes to be foreclosed, significant amounts of toxic debt still on the books of major financial institutions and the dire financial condition of state and local governments..  In addition there are the continuing problems of sovereign debt, the unsustainable boom in China and the threat of “beggar thy neighbor” policies as illustrated by the current trade and currency tensions between the U.S. and China.

Meanwhile, as in 2000 and 2007, the stock market is once again flying upward, feeding on its own momentum and the faith that governments will never let bad things happen.  The general feeling seems to be that fundamentals don’t really matter any more as long as the market is rising.   As past massive declines have proven, however, fundamentals don’t matter until they do.