A True Outsider’s Perspective

Good Evening: The U.S. stock market saw two substantial drops and rallies today before finishing roughly unchanged. Economic and financial worries can be blamed for the former, while the latter, especially the frenzied final hour pop, can be traced to hopes that the Obama administration is finally starting to decide what it wants to do in combating the financial crisis. Though today’s announcement about a plan to subsidize certain home loans is a step in the right direction, investors need to know whether Team Obama will stand by this and other proposals. Above all right now, investors seek clarity.

Stocks were on the defensive this morning even before jobless claims once again painted a bleak labor picture. Retail sales surprised everyone by actually rising, but the uptick was later dismissed as being due to seasonal adjustments (see BAC-Merrill’s take below). The major averages were down some 3% shortly after the opening bell rang, but those losses were more than halved by lunchtime. News that the Hartford had been kicked out of the Fed’s commercial paper program helped swing momentum back to the downside (see below). Equities set new lows in the afternoon, only to soar into the closing bell when the housing plan was released (see below). After a lot of volatility, the major averages finished mixed. Treasurys were lower after a weakish 30 year auction, though it must be said that prices have held in well this week despite substantial supply. Like stocks, the dollar was roughly unchanged, but, like bonds, commodity prices suffered modest losses. Though gold was once again higher, a 5.5% drop in crude oil was the decisive factor in today’s 0.75% decline in the CRB index.

To best explain why investors were so disappointed with Tim Geithner’s speech on Tuesday, as well as why they were so happy late this afternoon, let’s try a little thought experiment. Imagine you run a sovereign wealth fund on Mars, say the “Retired Employees Secure Capital Umbrella Entity”, or R.E.S.C.U.E. fund, for short, and you’ve been sent to Earth by your forward-thinking leadership. Earth is your preferred investment destination because word is starting to get around the galaxy that there is a credit crisis on the Blue Planet that will yield a patient investor a healthy rate of return over the long term. Upon educating yourself about the Earth’s markets and securities, what would you buy? Since you are known as the “Warren Buffett of Mars”, you might shift your gaze to the markets in the home country of the original “Oracle”. The U.S. has the largest and deepest markets, too, which should give an extraterrestrial buyer plenty of choices from which to pick securities with a built-in margin of safety for your investors back on the Red Planet.

After learning the ins and outs of EDGAR, and after boning up on U.S. financial history by reading the books of exceptional authors like Jim Grant, you might be tempted to have a peek at the latest analytical research from Wall Street. For a terrific, “where are corporate earnings and stock prices now in relation to historical norms” overview, you are drawn to the latest “Market Focus: Possible Futures”, courtesy of Credit Suisse (see attached). This piece depicts how equity prices in general have declined toward the lower end of the value range, though it also shows how stocks can overshoot and become even cheaper during times of tumult. Since 2009 represents just such a time, you might be tempted to look for bargains in the areas hardest hit during the 2007-2009 bear market. For equities, the financial stocks are the obvious candidates, while various mortgage securities represent some of the best potential opportunities in fixed income.

Before asking a kindly U.S. broker to help you identify and then buy the best values, you have one final question for him or her: “How is the U.S. government responding to this crisis, and how will these policies impact the values of financial stocks and mortgage-backed securities?” Momentarily stumped, your broker then takes your question as a cue to launch into a description of the various alphabet soup lending programs put in place by the Federal Reserve, as well as the stimulus package before Congress and the different possible plans recently outlined by Treasury Secretary, Tim Geithner.

“Fine”, you say, “but which programs have been settled upon, and what are the details describing how they’ll be implemented? Lastly, and this is important: Are these programs and/or the rules governing them subject to change?” Upon learning that the United States has a brand new administration at the helm and that they have yet to really determine exactly how they will tackle the myriad challenges before them, our would-be investor from Mars shakes his head and takes a pass. “I have to wait”, he tells his distraught broker. “I cannot invest until the rules become clearer and the policy proposals stop changing every day. Don’t feel too bad”, he says in trying to comfort his broker. “I can tell by reading stories on your internet that it appears all the other nations on earth have the same problem. Call me when you have some clarity on these issues, and I’ll set about investing on behalf of our R.E.S.C.U.E. fund”.

This little thought experiment is meant to show that while proposals, debate, and counter-proposals are to be expected in a democratic society, private capital cannot and will not invest in financial names and distressed securities until our nation settles upon a plan and implements it. Why would a Saudi Prince buy more Citibank when it might be nationalized? Why would the smart managers of a credit-based hedge fund scoop up certain tranches of RMBS when there are various “homeowners’ assistance” proposals being put forth by competing government agencies — each of which has different implications for individual mortgages and the structures that house them? Without clarity, private investors here on Earth will simply keep their wallets in their pockets.

Team Obama needs to settle on a plan, announce it, and then stick by it. Until the playing field stops shifting and until the rules stop changing, very few private investors will want to play the game. We need private capital because the problems are too large for the U.S. taxpayers to shoulder alone. Should our nation continue to address our financial woes in piecemeal fashion and without a clear and comprehensive plan, then our Federal Reserve may decide it has to step in. If forced, Ben Bernanke will live up to his helicopter nickname. The Fed will buy assets by the truck-load and simply monetize it all. If so, our Martian investor will probably just load up his spaceship with gold and fly home. We need clarity.

— Jack McHugh

Most U.S. Stocks Gain as Market Erases Tumble in Final Hour

Hartford Falls After Ouster From U.S. Commercial Paper Program

Home Prices in U.S. Slid 12% in Fourth Quarter, Most on Record

Treasury’s U.S. Housing Plan to Fund Interest-Rate Reductions

Seasonals at work on retail re.pdf


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