Market Talk

Let’s start putting some of the pieces of this puzzle together, shall we?

The news has been almost uniformly bad the past two weeks, unless you were the one person in your office pool who had Virginia Commonwealth. But stocks have been on a tear. Why, exactly?

We have a few facts from which to start constructing a theory:

- On March 16, the yen spiked, reaching Y76 to the dollar. The next day, finance ministers from the G7 nations held a conference call and agreed to intervene in the forex markets to put a cap on the yen.

- The DJIA and S&P 500 hit their year low on March 16.

- The yield on the U.S. 10-year Treasury note hit a year low of 3.20% on March 16.

Since March 16:

- The yen has appreciated no further, and currently resides around Y82.88.

- The DJIA is up about 6.5%. The S&P is up about 5.8%.

- The 10-year Treasury yield rose as high as 3.49% on Tuesday. Through Tuesday, it had risen every session since March 16, a streak that has not occurred since 1990.

Do not think these various things are unconnected. March 16 was a pivotal day in the global markets.

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I wonder how many more times in my life I’m going to have to say, “that’s the worst thing I’ve ever seen.”

“The time to look for the emergency aisles and where the exits are located is before takeoff, not after the wings fall off the plane,” Barry Ritholtz writes this morning at The Big Picture. He points to a Doug Kass list of calamities over just the past ten years, like the Sept. 11 attacks, Katrina, Haiti’s earthquake, and notes that these so-called “black swan” events occur much more often than we think, and it’s only common sense to be prepared for them.

But have we ever had so many all at once? The Japanese are suffering through three distinct disasters at the same time, the earthquake, tsunami and nuclear crisis. It is going to take them God only knows how long to get back to where they were Thursday, and anybody who blithely suggests the rebuilding will be a good thing because it will spur economic activity isn’t really watching what’s going on, and has a poor grasp of economics.

I don’t know about you, but to me, it feels like the world’s on fire these days.

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I have long thought that the scuttling of mark-to-market accounting as codified in FASB 157 is one of the most overlooked causes of the sudden, almost overnight improvement in the state of the banking sector that started near the market lows in 2009.

It was also a prime, prime example of crony capitalism. The banks wanted to get rid of mark-to-market, they needed to get rid of it, because if they had to mark all the lousy, bad loans to anything approaching reality, we’d suddenly find ourselves with a lot of suddenly insolvent banks. So the banks leaned on Congress, Congress leaned on the FASB, the FASB quickly caved and today we’ve got a bunch of zombie banks on our hands complaining that they’re burdened by too much government oversight.

But ultimately, there will be reckoning. It may be a sudden panic and collapse, or it may be more subtle, a slowly crumbling edifice that nobody notices is crumbling until one day it’s gone. At some point, though, somebody has to pay the piper. Who do you think that’ll be?

Our elected and appointed officials, in our name, abolished accounting rules that were inconvenient. Turned Fannie and Freddie into massive Hoover vacuums to suck up every bad mortgage in the nation. Debased the dollar. Spent trillions in government money and guarantees to protect a small band of connected players. We haven’t charge a single responsible person with any crime, criminal or civil.

Know the saying about not being able to spot the mark at a card game? You’re the mark, bub.

Barry Ritholtz breaks this thing down. Please go read the entire post. Here’s a snippet:

Many of the bailouts, mortgage mods and behaviors we have today exist to serve a single purpose: To allow the banks to kick the can down the road as far as they possibly can when it comes top their dual portfolio of bad mortgages and bank owned Real Estate (REOs).

Consider how ironic this is: From the GSEs becoming a dumping ground for every crappy mortgage to the failed policy of HAMP/mortgage mods, to the arbitrage between the the Fed’s ZIRP policy and Treasury’s 10 year bonds, nearly every reaction to the financial crisis has been a willful, concerted effort to kick the can down the road.

Rather than go Swedish, and force a shorter painful pre-packaged bankruptcy process, we have opted to take the long slow route.

The problem is with this strategy is we have more cans than road.

(Now, really, honestly, I planned to write this before Barry did a post about my Cramer post; this isn’t some mutual admiration society (although I do know and like him,) and it’s not like Barry needs the traffic boost from us.)

Okay, we’ve had some time to dig through and digest this morning’s jobs report. We’ve gotten over our initial surprise, we’ve read all the various takes on it from the Street, we’ve looked at what the markets did in response, we’ve put the broken shards in our mouths and chewed on them, to get the real taste of it all, and we’ve finally got out big picture take-away.

This report blows.

There really is no better way to put this. Today’s jobs report was awful, and not just because the initial numbers themselves were bad. The revisions to last year’s numbers were bad as well, and if you’re looking now for a trend, it’s this: the economy isn’t creating near enough jobs, not by a long shot.

That will have, as the econoboys like to say, ramifications.

Okay, quickly from the top: the economy added 36,000 jobs, the unemployment rate dropped to 9%. The first number is bad, the second number is good. But the reason the second number even exists isn’t good: the unemployment rate dropped because the labor force declined. The labor force declined because half a million people left the labor force.

If we took three million unemployed Americans, and dropped them into the Grand Canyon, the unemployment rate would plummet, know what I mean?

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Barry Ritholtz over at The Big Picture takes another shot at the bears who remain stuck inside their negative-feedback confirmation-bias thing, this time chastising them for missing a strong holiday sales season, where sales were up by the most in five years.

Why were the improved sales not a surprise to those people paying attention to the data? The negatives — weak job gains, housing overhang, consumer deleveraging, terrible municipal finances — were already well known all year. Even Oil over $90 was a not a big deal — it seems to have been in the $75-85 range for so long that gasoline over $3 had little shock value.

The newest data included more positives: Improving job market, equity gains, and an upcoming two percentage-point cut FICA payroll tax holiday in 2011. The 90.2% of the workforce that have jobs feel more secure (if they didn’t get laid off by now, they probably won’t). There is also a sense of widespread Recession fatigue; people are tired of living in bunkers, and are coming out to play again.

Now, we weren’t very impressed by November’s retail sales figures, because when you broke them down, adjusted for inflation and per capita spending, they were weaker than the headlines indicated. So I’ll reserve judgment on December’s as well, even if that means I risk falling into my own feedback loop.

On a side note, one thing I have to take issue with specifically if this idea that if you haven’t been laid off yet, you’re probably not going to be. Companies may not be laying people off by the hundreds of thousands anymore, so the probably qualifier qualified it well, but they’re still laying people off. I know, because I know several people who have been laid off in the past month of two. Companies are still managing their costs ruthlessly, and the best way to keep costs down is to lower headcount. I don’t see how people in general aren’t aware of it, either.

Michael Panzner over at Financial Armageddon points to another reason why those Christmas sales looked so good: transfer payments.

One of my bigger mistakes, however, was underestimating the extent to which government transfer payments — unemployment insurance, food stamps, social security benefits, etc. – aided consumer spending and, by extension, the overall economy. As Global Economic Intersection estimates in “Personal Transfer Payments and GDP,” the accumulated value of “extra” transfer payments Americans received from 2008 to 2010 — that is, the amount over and above the long-term trend — worked out to about $569 billion.

That is not an inconsequential sum. We’ve been harping on the issue of transfer payments for some time. The government sends some money people’s way, people spend it, and everything looks all peachy again. Meanwhile, unemployment’s high and stagnant, and wages are broadly flat. This was the real reason people were so nuts over the tax-cut debate, a very real fear that any added burden on the consumer will just torpedo the recovery. It’s why the White House caved.

We do not have a self-sustaining recovery as long the federal government is underwriting the populace’s spending habits to such an extent. We have government-induced economic activity.

I still think that the most important metrics to follow, indeed the only ones that really matter, are jobs and wages. The rest is noise. For this recovery to be anything more than smoke and mirrors, you’re going to need to see employment and wages rising, steadily, month after month, for some time. I’m not talking about 40,000 jobs a month and a tick higher in wages. I’m talking about hundreds of thousands of jobs per month, and wages that are well outstripping the inflation rate.

When I see those things, I’ll let my guard down.

Barry Ritholtz over at The Big Picture has been on this saw lately about how people are missing out on this rally while they sit around waiting for another disaster to hit. He’s been razzing the perma-bears with this gaudy stock market that keeps rising. He can’t seem to understand why people aren’t getting on board, regardless of any fundamental concerns.

I know Ritholtz a little, and I like him and respect him a lot, I think he’s a very, very smart guy, and often agree with his views on a range of subjects. But he’s got this one wrong. He knows why people aren’t jumping back into the stock market, despite the seemingly parabolic rise in stocks.

The simple answer is, people don’t trust the stock market anymore. This is something Ritholtz himself wrote a year or so ago (can’t find the link, but remember specifically reading it.) What’s that old saying? Fool me once, shame on me, fool me twice, shame on you. Well, mom and pop were fooled, twice, badly. In the wake of the credit crisis, Wall Street was exposed as a nearly habitually corrupt operation, and the everybody knows the market’s gains have more to do with the Fed pumping money than any fundamentals.

That brings me to the essay “Have Stocks Become a Sucker Bet?” by Peter Morici, an economics professor at the University of Maryland. I was going to just clip a few grafs, but it’s worth reading in its entirety. In a nutshell, Morici lays out why the average investor doesn’t stand a chance compared to the pros, who have the gamed the system to the point where any upside is captured long before it can trickle down to the retail investor. This is something people are coming to understand instinctively, I believe, given how much more information is available to today’s investor than to investors 10 or 20 years ago.

Actually, as one of the biggest and best financial blogs, The Big Picture has been a contributor to the distrust. Ritholtz has for years been deflating market myths used to lure in the suckers, and has provided time and time again the evidence to support to little guy’s mistrust.

From Morici:

With corporate profits breaking records, Wall Street anxiously anticipates the return of the individual investors to the stock market. It may be a long wait, because the little guy may have concluded investing in stocks is a sucker bet.

Investors, as opposed to traders, buy stocks in companies whose profits they expect to rise. The conventional wisdom says stock prices will follow profits up, but over the last two business cycles, that simply has not happened.

In February 1998, the S&P 500 first closed above 1000. From the first quarter of 1998 to third quarter of 2010, corporate profits were up 203 percent but the average daily close of the S&P 500 was up only 7 percent—about one half percent a year.

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Barry Ritholtz, over at The Big Picture, seems be getting a lot of the Zero Hedge traffic these days. Because, he says, he’s been getting hit over the head with emails from readers bashing him for not bashing the market:

A composite of their emails would read something like this: “How can you sit there so blithely while the Fed debases the world’s reserve currency? Why haven’t you commented on POMO?!? The entire game is rigged, and your just another @%$# salesman for Wall Street!”

Ritholtz argues, quite rationally, that his primary job is money management, and right now, there are obvious reasons to be in the stock market. (The biggest one is spelled F-E-D.) While he expects a correction of some sort, he chastises the doubters. “The folks who missed an 85%  generational run up in equities will pound their chests and say “See, we told you so!” And they will have made absolutely no money in the process.”

Do you want to be right, he asks, or do you want to make money?

Of course, some of those doubters undoubtedly got out before the crash, and lost absolutely no money in the process. In fact, depending upon what they actually did with their money after pulling it out of stocks, they may have even made money, while the vast majority were getting taken to the cleaners. Comedy, as Steve Martin said, is all about ti-ming.

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Stocks have been rallying almost unabated since March 2009. Bonds have been rallying too. Those two assets are telling two very different stories. In the stock market, it’s recovery time, it’s corporate America getting back to doing what it does best, produce profits for its owners. In the bond market, it’s a much darker vision, it’s a slide into recession, renewed banking crises, terrorist attacks. Those are two very competing visions, but if you just follow where the money’s going, you can see which story has more currency with the investing public.

From the Journal:

The stock market just posted its best September in decades, but hardly anyone seems to be joining the rally. Hedge funds, high-frequency trading firms and individual investors have all cut back on stock trading, leaving third-quarter trading volume 25% below the level in the second quarter.

Trading on the New York Stock Exchange, the Nasdaq Stock Market and the American Stock Exchange is averaging 7.1 billion shares a day for the past three months, far below the 2010 average of 8.8 billion shares a day and back to levels not seen in more than two years.

I’ve had this sense lately that the stock market isn’t actually telling us much. Oh, it’s telling us that corporate America is healthy again, but you don’t need the stock market to tell you that. Just look at the earnings reports.

The stock market has this hold in the popular imagination, and when it’s rising, most people assume that means the economy is doing well. The stock market is telling corporate America’s going to post record profits over the next year. Yet Americans’ wages are flat, when 15 million people are out of work, when thousands of people are exhausting even two years of jobless benefits and tumbling into oblivion. It seems there’s a disconnect between the real world and the stock market.

There is no disconnect, however, between the real world and the bond market, and that’s where the money’s going.

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I meant to highlight this earlier this week, but just got caught up in all manner of other things. Still, this week’s must read is Barry Ritholtz’s post at The Big Picture, “The Left-Right Paradigm is Over: It’s You Vs. Corporations.” Ritholyz says the old left-right split, a clear fault line since the heyday of Abbie Hoffman, has been replaced by a new fault line. If you’re a CEO, you may want to avert your eyes:

We now live in an era defined by increasing corporate influence and authority over the individual. These two “interest groups” – I can barely suppress snorting derisively over that phrase – have been on a headlong collision course for decades, which came to a head with the financial collapse and bailouts. Where there is massive concentrations of wealth and influence, there will be abuse of power.  The individual has been supplanted in the political process nearly entirely by corporate money, legislative influence, campaign contributions, even free speech rights.

This may not be a brilliant insight, but it is surely an overlooked one. It is now an individual vs. corporate debate – and the humans are losing.

Everybody plays this left-right split like it’s Monday Night Football. We cheer and root for “our team” to win, win elections, win debates, just win. The right has a rally in Washington. The left has a rally in Washington. All the problems in the world are seen through this prism and the other side is always at fault. It’s an easy, familiar split, something even media pundits can grasp.

But that left-right split is just not the important one anymore. It’s not the fault line that matters.

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Over at The Big Picture, Barry Ritholtz does a big “what if” on the 2008 financial crisis, positing an alternate-universe timeline in which the banks were bailed out. It reads like one of those Star Trek episodes where Kirk and Spock find themselves in a universe where Edith Keeler never died and everything is different.

Imagine a nation in the midst of an economic crisis, circa September-December 2008. Only this time, there are key differences: 1) A President who understood capitalism requires insolvent firms to suffer failure (as opposed to a lame duck running out the clock); 2) A Treasury Secretary who was not a former Goldman Sachs CEO, with a misguided sympathy for Wall Street firms at risk of failure (as opposed to overseeing the greatest wealth transfer in human history);  3) A Federal Reserve Chairman who understood the limits of the Federal Reserve (versus a massive expansion of its power and balance sheet).

I won’t spoil the fun for you, head over there and read the whole thing, it’s well worth it. If you’re a corporate bond-holder or creditor or counterparty, you’ll be glad Ritholtz wasn’t part of the White House cabinet. If you’re a taxpayer, you’ll wish he had been.

Incidentally, doing this little thought experiment, putting the two time lines side-by-side, reveals the one huge difference between what should have been and what was that led to our current reality: in Ritholtz’s experiment, there is no kleptocracy, no corrupted political machine being crudely wielded by the private sector for its own benefit. No string pulling.

All the bailouts, all the intervention was done in the name of the people, but make no mistake, it was done to save private players from the consequences of their own bad decisions. People innately understand this, but have no way to “fix” it. What’s done is done. That’s led to a lot of lingering hostility, which isn’t likely to go anywhere until somebody figures out how to focus it. Which, come to think of it, I believe the tea party is doing pretty well right now.