Tuesday, January 12, 2010

"Dubya"

If you think this week's post is about the last President of the United States, you're wrong. Instead, it's about the esteemed 23rd letter of the alphabet: "W."

In English, we pronounce it "double-yoo," where "yoo" is the 21st letter of the alphabet, "U." But in France, it is pronounced "double-vee," using the letter "V" to more accurately describe the shape of the character.

"Double V" shapes are not unknown to those who work in the finance industry. The shape to which I am referring is the shape of the graph that the DJIA makes when you look at it over a long period of time. (And for those of you who are day traders, John Magee's gospel on the subject of graph, or technical, analysis said and proved that short term graphs really aren't worth the time to watch them if you're looking for patterns.) Essentially, the situation ends up like this:
  1. Stocks take a huge dive from near highs.
  2. At the bottom, speculators buy stocks because they are at such good prices.
  3. Stocks go up, but because the underlying fundamentals of the stocks don't support the new run-up in prices, there is much less momentum on the upswing.
  4. As the prices approach the top, the speculators get out having made their profit.
  5. Since no one else feels the stocks are a good buy and are in fact overvalued their prices collapse under their own weight.
  6. Eventually, the underlying companies get their act together and the stocks make a momentous climb again.
There is a fair amount of debate as to whether we are in a true resurgence of the upward trend from the pre-mortgage meltdown days. Many analysts seem to think that we are. My boss, who was a trader in a previous life, swears to me that the income statements support the companies' run-ups in price.

But there are those contrarians, like myself, who feel that the unresolved housing situation coupled with the state of (un)employment represent a double-whammy that will suck the life out of any long term increase in price. And after the January bounce wears off (due to portfolio rebalancing) it is my firm belief that stocks will resume their trend downward.

It is to be noted that this is a complete reversal from a stance I took when discussing the topic with some friends when the market initially dove (in late 2007). I had said then that the stock market would be over 9,000 again by July 2009. While I was right (albeit off by a month, since it didn't cross the 9,000 mark until July 30), I must confess that at the time I was expecting a "normal" recovery.

That was then, before the housing market decided to stay in the doldrums. Before we had double digit unemployment. And certainly before economists started saying that unemployment will take quite a while before it returns to it's historical average of 5%. Looking at this, it isn't difficult to see how this general malaise can (and will!) have an effect on the attitude of the consumer, the small business, and then the large business as the trickle up effect takes hold.

The real question in my mind now is how will Wall Street react with regards to the "New Deal" bonuses that are being paid now. For those who haven't heard, a number of firms are now planning to award bonuses that are less cash heavy and more stock heavy. But, as a bonus (pun intended), there are "claw back" clauses that essentially mean the company can take back the bonuses if the company's long term performance suffers.

If I had to make a guess, I would say that there will be no effect. Not only do I have little confidence in the morality of the financial services industry, the normal rules of finance do not seem to apply to them. Specifically, there is an adage that says:

"The bulls make money; the bears make money; the pigs get slaughtered."

The problem is that, in this scenario, the pigs always make money because they find ways to skirt the touchy subject of ethics while (usually) not breaking the law. Don't believe me? Consider the Galleon insider trading criminal case that is currently ongoing. Or consider the behavior of two prominent financial services firms that I discussed last week. Are they breaking the law? Perhaps. But one thing is for sure: they are making money, and scads of it. If you're following me on Twitter, you've seen my scathing commentary on these companies especially as it pertains to the payouts that will be starting in the new few weeks.

It's enough to make me nauseous, honestly. And while I recognize (and even know personally) that there are individuals in that industry that do have a conscience, I (and the American Public) are being inundated with news report after news report of how these companies do not believe there is anything wrong with what they've done. Read the excellent op-ed piece by Frank Rich in last Sunday's New York Times if you want another person's view on this topic.

So I'll say it again: bring back Glass-Steagall!

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