Valid Points Vs. Head Scratchers
First, let's take a look at the VALID reasons to be more optimistic going forward that we received this week. We continue to get "less bad" news out of housing, and while I agree with the bears that the housing market is not going to look anywhere close to good anytime soon, it seems to me that we're in the process of putting a bottom in here (see the last few posts for the details). As I've written before, you have to start the recovery process somewhere, and that somewhere is a pickup in foreclosed home sales. This week, we got another piece of relatively positive housing info in the form of pending home sales, which added to, dare I say, a string of "less bad" housing data. So the hits keep on coming in housing, and it's hard for me to argue with folks taking at least a little heart in this.
The second, and more important, piece of positive news this week was the FASB's decision to change the mark to market accounting rules. Again, I've written a bit on this in the past, so I won't dive into gory details, but until now, banks have had to mark the "value" of their holdings of assets like mortgage backed securities on their balance sheets to current market prices. The problem with this is that, in many cases, the market for these assets has completely dried up. There is no market. Therefore, banks have had to mark the value of assets, many of which probably carry substantial value if held to maturity (remember that prime default rates are around 3% and subprime are at about 16-17%, implying that most borrowers are current, even if default rates rise further), to fire sale prices, bringing along with the markdowns the need to raise substantial amounts of capital in order to keep their capital cushions where they need to be and thus substantially hampering the ability to lend.
What the FASB has done is to give banks that are pledging to hold these assets to maturity substantially more leeway in valuing them, based not on "market value" but rather on an analysis of the actual cash flows and delinquency rates of, for instance, the underlying mortgages that make up the securities in question. Now, to be sure, some of the toxic stuff that the banks hold and has been marked down substantially is worthless or close to worthless, but some of it surely is not. So this change should help in terms of actually freeing up capital in the banking system as certain assets are marked back up, hopefully helping to get the credit markets going again by spurring (hopefully more responsible) lending.
In my humble opinion, this was a logical thing to do. My question is what in the world took them so long? It's a trifle maddening that we probably wouldn't have gone so far down the slippery slope as we did had the FASB simply stepped back and thought about this last Fall. Nonetheless, we'll chalk the move up to a very nice positive, however late.
So we indeed had a couple of positive arrows in our quiver this week, and the market responded by rising (I can't begrudge it for doing so, and I'll certainly take it). However, I can't shake the sneaking suspicion that we may be setting ourselves up for near term disappointment in here. The sigh of relief is simply getting too loud, and it just seems to me that too many talking heads are a little too quick in declaring the end of the recession. Remember, these were the same loudmouths that just a few weeks back were calling for Dow 5000. There also seems to be a whole lot of "stretching" going on. What I mean by this is that these new bulls seem very quick to now take datapoints or news stories and spin them more positively than warranted.
A quick case in point: the G-20 summit. President Obama heralded the summit as an "historical turning point" in the global recovery and the press ate it up. I'm sorry, but you can't be serious. Someone please explain to me how ending tax havens, regulating hedge funds, and providing $550bln to the IMF is going to change the game substantially here. Do I think that hedge funds should be regulated? Yes I do. Do I think that the IMF should have enough moolah to help emerging economies out? Sure. Will this help the Eastern European situation from getting worse and spinning out of control? I sure hope so. The fact that these leaders actually got something done should be seen as a major victory, as most of these things are nothing more than a complete waste of money and time. However, while the leaders were veering to the left, they seemed to forget why they were really there and didn't accomplish much in terms of really stimulating the global economy. Even the ECB's rate cut left a lot to be desired as it, once again, is showing how laughably out of touch it is with reality.
In sum here, what really gives me pause is not that little on the stimulus front was accomplished at the G-20 (my expectations couldn't have been lower). Rather it's how quick investors were willing to buy into the BS that something substantial WAS accomplished. This to me points to over-optimism.
Data = Not So Hot
Turning to economic datapoints, there was little signs of change in trend this week. Bulls were quick to jump on the fact that the ISM manufacturing index came in above expectations (rising month over month for the first time in many months, although still well below breakeven) with new orders rising 1.8%. However, last month's new order number was revised substantially lower, from -1.8% to -3.5%, so it seems very, very premature to break out the party hats here (One point of reference: it pays to watch the direction of revisions, sometimes even more so than the actual numbers themselves in order to discern a true change in trend. So far, no good).
Sticking with the ISM, the services index was released this afternoon and it showed no bright spots, declining for the 6th consecutive month. Importantly, new orders also continue to decline (dropping from 40.7 to 38.8, with 50 indicating break-even). New orders presage hiring, and with ~75% of American workers employed by the services sector, this doesn't augur well for any change in the employment trend we've seen of late, which was reinforced with the March payroll number this morning. The 663K March payroll decline and 8.5% unemployment rate were as bad as advertised, but the real attention grabber was the revision (again, watch 'em!) to January's payroll decline number to a whopping 741K from the mid 600K's. 3rd worst reading on record and the other 2 were due to the end of WWII and a couple of massive strikes in '49. OUCH!!!
Now, I have and will continue to pound home the fact that unemployment is a notorious lagging indicator, and I have no reason to believe that this is not going to be the case this time around. However, I would point out that a couple of the "less bad" data points that got this rally going centered on consumer spending and confidence. In fact, it looks as if overall consumer spending actually ROSE quarter/quarter in the 1Q, even in the face of the continued deterioration in the employment situation. While I wish it were the case, I do not expect this to continue given the state of the labor market at the moment. I don't see how it's possible. To drive this home, according to Gartman this morning, an important industrial shipping measure fell 22% for March, which is counter to the usual seasonal trend (generally March shipments are up as companies prepare for the summer selling season). Therefore, this grabs my attention as well, and as one puts the puzzle pieces together, it seems logical that the optimism on the consumer front that we've run into over the past few weeks may easily give way to a new bout of pessimism before too long.
Perge Sed Caute (Proceed With Caution)
Soooooo, I'll conclude thusly: severe bear markets do not historically end with sharp reversals to the upside. They tend to end as selling is exhausted and the market limps sideways for a bit before heading higher. Bear market rallies, however, are generally sharp, much like what we've seen lately, so I'm wary here.
Can the upside continue? Absolutely! We are seeing progress on a number of fronts, and I will once again note that, in my opinion the intermediate low has been put in. However, I also think that investor optimism may have begun to run ahead of reality. The economic recovery is not likely to be sharp, and the numbers are very likely to bear this out as we move through the next few weeks (it's all about puts and takes for a while folks and I think we've had our share of takes over the past few weeks). We've had positive actions out of the Fed and Treasury which should help the economy out in due time, but in the meantime, we have to deal with a likely reversal (at least for a while) in the direction of consumer data, the release of the results of the banks' "stress tests" (I'll eat my hat, which I wear a lot these days, if a couple of banks aren't shown as inadequately capitalized, lest the test be seen as a total farce), and the 1Q earnings "confession season".
So in sum, traders, I think it's time to take profits and/or hedge long positions. As for investors, I'd consider this: if you've been waiting for an opportunity to re-tool your portfolio by getting rid of the weaker sisters, now may be the time to do so. While I don't want you out of the market, you might have a chance here to upgrade the quality of your portfolio. Use the recent bounce to rid yourself of the names who's time has passed and use what I see as the potential for near term market weakness to initiate positions in names with better prospects. Have those wish lists handy and act!
Have a super weekend and pass the word!!!
TRB
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Bird,
ReplyDeleteAnother good one - always post you to my Twitter.
See you in May.
T