Market Commentary for the week of January 20, 2009

Bonanza.
Did you cash your billion dollar check today? It seems that anyone who asks, and some who don’t, is getting a bailout check for several billion dollars. Whether to shore up a deleveraged balance sheet, or to acquire a competitor, or simply to forestall the inevitable, cash is flowing into corners and crevasses that had previously never seen the light of day. Many, if not most, of the same corporations that showed poor governance the first time around are being given financial “second chances” with your money. Many offer assurances that “it won’t happen again.” More, still, are smiling like the Cheshire cat, and dismissive of admonition for success.

Bailout or not, the latest news is prompting concerns around the globe.

In country after country, gross domestic product (savings, consumption, exports) is falling, representing a serious gathering of downgrades and bankruptcies. After the market’s early year (one week) explosion out of the box, things have settled back into a secular decline which, in reality, never went away. The upswing in equity prices since October/November last year was simply the “third leg” in an intermediate bull cycle within the more enduring global bear phase.

And Wall Street is the least of our problem.

Quantitative decline.
The decline in equity prices is directly attributable to poor consumer sentiment. When one’s job is threatened, discretionary spending is the first to suffer. However, not only are “superficial” purchases declining, but basic necessities are becoming either/or decisions both for corporations and individuals.

My models show a decline in earnings acceleration patterns that rival historically moribund periods. The average P/E has declined from 20 to 7 in the last 12 years, with the highest reversion occurring in the last 2½ years. There is still money to be made in stocks, but a buy and hold strategy no longer works for all equities, or in an environment of extreme volatility like today.

The dual problems of poor governance and greed are still here despite our government’s best efforts to undo the past. Regulators are not regulating, banks are not lending, investors are not investing.

While I am in principled agreement with the global stimulus, I am wary of overreacting to the problem. Methodologically, I think that extensions to market cycles that are man-made are disruptive to the recovery rate. To conclude that “the gains outweigh the risks” is false because the values that created the problem are not being addressed. The debate should not be about bailout amounts, but about bailout responsibilities. After all, under previous monetary policy, money was readily available, and ultimately led to the leveraging not only of valuations, but expectations. In the meantime, leveraging our morals is not an option.

When everyone was making money, there was no imperative to change the moral culture. On Tuesday, the United States inaugurates not only a new man to the office of President, but, hopefully a new moral imperative to get it right.





The financial markets will be closed on Monday, January 19th in honor of Martin Luther King Day.