In today's looney bin of a stock market, what was thought to be truth has turned out to be fiction. And fiction writers couldn't have invented what seems to be true. Here's a sampling.
1. First, ignore all the economists. There are no economists with consistently strong records of predicting the direction of the economy. There are no economic models that explain much of anything. Forget what the economists say.
2. Be a Liberal. If there is one force that has supported the economy and uplifted the markets, it's government. The emergency credit offered by the Fed and central banks of other major economic powers, along with the bailouts and fiscal stimuli provided by the U.S. and other governments, pulled the world economy out of its biggest downswing since the time of Prohibition. Today's revelation that in 2008 and 2009, the Fed loaned out $9 trillion, or $3 trillion, or however one wants to total up the numbers, to support everyone from Goldman Sachs to McDonald's to Europe's central banks illustrates that in times of crisis a strong Fed can make a difference. Whatever one might think of GS or Europe, America without Big Macs and fries with that would be a disaster.
Fair questions have been asked about the Fed's current adventure in quantitative easing. On one level, it is apparently a stock market manipulation designed to induce consumer spending by creating a wealth effect. In general, governments don't manipulate asset values without eventually producing catastrophic consequences (see 2008 real estate crisis for further reading). But today's stock markets embrace governmental action and become deliriously exuberant whenever another bailout or easing is announced.
News reports tonight indicate that the United States is now prepared to join in a bailout of the Euro bloc, since Portugal, Spain and who knows what other countries seem to be in line for a handout. The stock markets should soar at the prospect of another federal giveaway.
3. Mind the debts. The past twenty or so years, a/k/a the Age of Leverage, saw shiploads of bad loans made to home buyers, credit card customers, businesses, nations, states, cities and anyone else not previously mentioned. These debts, in gigantic amounts, remain with us, and lurch around the financial system looking for someone or something to crush. Every time they look like they're circling a victim, the markets shudder. Ireland's recent "rescue" (which was really a rescue of banks holding Irish debt) is illustrative. As before, governments and central banks mounted up and sallied forth, with the William Tell Overture playing in the background. Dealers in the financial markets had a nice profit opportunity, trading the markets down and then up. Investors might have been left feeling like hit-and-run victims. The herd of bad debts will be with us for years. Indeed, as bailout follows bailout, the can is being kicked down the road only to haunt us farther into the future.
4. Statisticapalooza. The markets obsessively fixate on all variety of statistical minutiae, ranging from retail sales results for a single day to self-declared sentiments of consumers to inflation figures that exclude any items that might reveal inflation to the differences in borrowing costs between, say, Belgian and German debt. Small bits of information become large symbols. Rational analysis is kicked into the gutter.
The stock market is like a duck billed platypus. If you look at it, you think it can't be true. But apparently it is. Weirdness is the world. The only certain way to make money is to be the Fed and print it. Everyone else might think about eating cake.
Showing posts with label stock market in 2010. Show all posts
Showing posts with label stock market in 2010. Show all posts
Wednesday, December 1, 2010
Sunday, November 14, 2010
Fallout From the G-20's Failure
Last week's G-20 meeting in Seoul was a failure. Basically, nothing got done, except for an exchange of volleys of antagonistic pronouncements. The major exporting nations--especially China and Germany--criticized America's profligacy and continued monetary easing. America called for structural change from the exporters, demanding that they boost domestic consumption and depend less on selling in America. U.S. officials scolded China for artificially depressing the value of its currency. The group as a whole issued a statement that muttered something about one for all and all for one. But the casual observer might wonder how many members had their fingers crossed behind their backs when they signed the statement.
As the meeting broke up, France's president, Nicholas Sarkozy, began a one-year term as the leader of the G-20. He immediately announced that the tasks at hand would take more than a year to complete, thereby absolving himself of responsibility for producing results. This inspiring act of leadership made clear that there ain't gonna be much happening soon G-20wise.
Perhaps we shouldn't have expected much. The history of the U.N., and before that the League of Nations, teaches that international organizations are always partial to dysfunction. Nevertheless, some world leaders raised expectations. The potential fallout from the failure isn't pretty.
Cranky Financial Markets. In the last couple of weeks, as it became increasingly clear that the G-20 meeting would be unsuccessful, the financial markets hesitated and then fell. Stocks and bonds are both lower (after anomalously rising together). Commodities have fallen back. This isn't surprising. For the past two years, governments worldwide have been transferring risk and losses from the financial markets to taxpayers. Speculators were probably hoping the G-20 would give them yet another undeserved windfall. But taxpayers in Europe and America have rebelled. Faced with risks that aren't being dumped on innocent bystanders, financial market players have apparently chosen to trim their sails.
Policy Makers, Be Not Proud. One thing is for sure, today's financial and economics policy makers are dead set on avoiding the governmental mistakes of the 1930s, which today's conventional wisdom holds responsible for turning a nasty recession into the Great Depression. Most central bankers and other policy makers seem to think they know what their predecessors did wrong, and how to avoid making the same mistakes. But the failure of the G-20 meeting is disquieting.
The member nations were simply doing what was in their interests. They weren't intent on messing up the world's economy, nor did they want to exacerbate the already rising tensions among them. They simply couldn't levitate themselves above their conflicting national interests to the supranational lovefest that the G-20 is supposed to foster. Each nation's domestic politics dictated its views. With the world economy too small a pie for every nation to get as much as it would like, we're now edging toward an international game of musical chairs.
And that's the way it was in the 1930s as well. None of the central bankers and other policy makers of that era whose mistakes are now so routinely and condescendingly decried meant to create a train wreck. Like their modern counterparts, they consulted with each other and tried to find common ground for constructive action. But they were driven, like today's policy makers, by the interests of their own nations. They looked at the rest of the world from differing frames of reference, each crafted by parochial interests. Yes, they blew it. But they weren't gonzo idiots. They simply did what nations generally do in times of international disagreement.
The G-20's failure last week is a disconcerting reminder of the way things fell apart in the 1930s. The G-20 also failed to find common ground, and their pledge to continue working together seemed like little more than press fodder to divert financial reporters while world leaders caught their flights out of Seoul. Before the Fed, the Treasury Department, and other policy makers in America and elsewhere confidently conclude they know how to avoid the mistakes of the 1930s, they ought to step back and think about what just happened. Human nature hasn't changed in the last 80 years. Even though the Fed is taking a sharply different tack from the Fed of the 1930s, its most recent quantitative easing program may provoke the currency, trade and other economic conflicts among nations that hindered recovery during the 1930s. The doyennes of central banking and fiscal policy should be not proud. Their deep and prolonged studies of the Great Depression, and the advantage of hindsight, may still be insufficient to keep us from falling into the abyss. When a group cannot agree on shared sacrifice for the greater common welfare, divided they will have to make their individual ways in a treacherous world.
As the meeting broke up, France's president, Nicholas Sarkozy, began a one-year term as the leader of the G-20. He immediately announced that the tasks at hand would take more than a year to complete, thereby absolving himself of responsibility for producing results. This inspiring act of leadership made clear that there ain't gonna be much happening soon G-20wise.
Perhaps we shouldn't have expected much. The history of the U.N., and before that the League of Nations, teaches that international organizations are always partial to dysfunction. Nevertheless, some world leaders raised expectations. The potential fallout from the failure isn't pretty.
Cranky Financial Markets. In the last couple of weeks, as it became increasingly clear that the G-20 meeting would be unsuccessful, the financial markets hesitated and then fell. Stocks and bonds are both lower (after anomalously rising together). Commodities have fallen back. This isn't surprising. For the past two years, governments worldwide have been transferring risk and losses from the financial markets to taxpayers. Speculators were probably hoping the G-20 would give them yet another undeserved windfall. But taxpayers in Europe and America have rebelled. Faced with risks that aren't being dumped on innocent bystanders, financial market players have apparently chosen to trim their sails.
Policy Makers, Be Not Proud. One thing is for sure, today's financial and economics policy makers are dead set on avoiding the governmental mistakes of the 1930s, which today's conventional wisdom holds responsible for turning a nasty recession into the Great Depression. Most central bankers and other policy makers seem to think they know what their predecessors did wrong, and how to avoid making the same mistakes. But the failure of the G-20 meeting is disquieting.
The member nations were simply doing what was in their interests. They weren't intent on messing up the world's economy, nor did they want to exacerbate the already rising tensions among them. They simply couldn't levitate themselves above their conflicting national interests to the supranational lovefest that the G-20 is supposed to foster. Each nation's domestic politics dictated its views. With the world economy too small a pie for every nation to get as much as it would like, we're now edging toward an international game of musical chairs.
And that's the way it was in the 1930s as well. None of the central bankers and other policy makers of that era whose mistakes are now so routinely and condescendingly decried meant to create a train wreck. Like their modern counterparts, they consulted with each other and tried to find common ground for constructive action. But they were driven, like today's policy makers, by the interests of their own nations. They looked at the rest of the world from differing frames of reference, each crafted by parochial interests. Yes, they blew it. But they weren't gonzo idiots. They simply did what nations generally do in times of international disagreement.
The G-20's failure last week is a disconcerting reminder of the way things fell apart in the 1930s. The G-20 also failed to find common ground, and their pledge to continue working together seemed like little more than press fodder to divert financial reporters while world leaders caught their flights out of Seoul. Before the Fed, the Treasury Department, and other policy makers in America and elsewhere confidently conclude they know how to avoid the mistakes of the 1930s, they ought to step back and think about what just happened. Human nature hasn't changed in the last 80 years. Even though the Fed is taking a sharply different tack from the Fed of the 1930s, its most recent quantitative easing program may provoke the currency, trade and other economic conflicts among nations that hindered recovery during the 1930s. The doyennes of central banking and fiscal policy should be not proud. Their deep and prolonged studies of the Great Depression, and the advantage of hindsight, may still be insufficient to keep us from falling into the abyss. When a group cannot agree on shared sacrifice for the greater common welfare, divided they will have to make their individual ways in a treacherous world.
Sunday, September 26, 2010
Wall Street's Contribution to the Democrats
Business interests evidently are contributing more money to Republicans than they did in 2008. Cash flow to Democrats from people who might pay estate taxes has fallen sharply. But the financial markets have been kind to the Democrats. The stock market has bounced up nicely thus far in September, and bonds continue their improbable two-decade bull market. Gold is flirting with new highs on almost a daily basis. Silver has rallied. Oil has edged down, as it usually does following the end of the summer driving season. But it hasn't edged far. One can hardly find a financial investment that isn't doing okay or better than okay in September.
Republicans might claim that the cheery financial markets are the result of their resurgence. But good news has a thousand parents, and political incumbents generally get some credit when investors benefit. Most of today's boat rockers are middle or moderate income folks living outside the Beltway, who feel they are about to lose the little that they have after years or decades of work. There are about as many investment bankers among Tea Partiers as Zionists in Iran.
The middle of the road voters who will decide the outcome of the mid-term elections will think about their 401(k) accounts as well as their taxes. Five weeks remain until the mid-term elections. October has been an unpredictable month for the stock markets. There is certainly reason to wonder if the markets won't fall. Corporate earnings announcements, set to begin next week, aren't expected to glow. Banks may report lower earnings, from a drop in stock market trading volume. Tech companies earnings could stagnate, as consumer demand has drifted. Trade skirmishing is flaring up. The U.S. is jawboning China about the yuan, and China has slapped tariffs on American chicken parts. Japan is trying to weaken the yen in response to the weakening dollar (something that may affect China and its dollar-linked yuan more than America, since China is Japan's largest trading partner). The European debt crisis is rumbling again. Portuguese and Irish debt are losing favor, and Greece's likelihood of defaulting is growing (although no default appears imminent).
Nevertheless, the financial markets have spent the last four weeks looking at silver linings, not clouds. That's not likely to change, unless something big and bad breaks in October. Otherwise, the financial markets, still holding a 60% stock market gain since the March 2009 low, will give a nice gift to the Democrats.
Republicans might claim that the cheery financial markets are the result of their resurgence. But good news has a thousand parents, and political incumbents generally get some credit when investors benefit. Most of today's boat rockers are middle or moderate income folks living outside the Beltway, who feel they are about to lose the little that they have after years or decades of work. There are about as many investment bankers among Tea Partiers as Zionists in Iran.
The middle of the road voters who will decide the outcome of the mid-term elections will think about their 401(k) accounts as well as their taxes. Five weeks remain until the mid-term elections. October has been an unpredictable month for the stock markets. There is certainly reason to wonder if the markets won't fall. Corporate earnings announcements, set to begin next week, aren't expected to glow. Banks may report lower earnings, from a drop in stock market trading volume. Tech companies earnings could stagnate, as consumer demand has drifted. Trade skirmishing is flaring up. The U.S. is jawboning China about the yuan, and China has slapped tariffs on American chicken parts. Japan is trying to weaken the yen in response to the weakening dollar (something that may affect China and its dollar-linked yuan more than America, since China is Japan's largest trading partner). The European debt crisis is rumbling again. Portuguese and Irish debt are losing favor, and Greece's likelihood of defaulting is growing (although no default appears imminent).
Nevertheless, the financial markets have spent the last four weeks looking at silver linings, not clouds. That's not likely to change, unless something big and bad breaks in October. Otherwise, the financial markets, still holding a 60% stock market gain since the March 2009 low, will give a nice gift to the Democrats.
Thursday, March 11, 2010
The Democratic Stock Market
If you believe what many Congressional Republicans and Tea Partiers are saying, the stock market should be down around 3,000. The deficit spending, tax raising Obama administration, hellbent on an expensive reformation of the health insurance system, would surely have driven the economy into the ground by now, with a socialist wasteland our only future. But the market is reaching post-crash highs almost every trading day, and scarcely a wisp of a cirrus cloud mars the clear blue skies over Wall Street.
The stock market and the conservatives can’t both be right. If conservative, free market economists correctly propound that stock prices rationally incorporate all public information, then the Democrats must be on the right path. Onward with health insurance reform, tax increases, etc. Otherwise, you'd have to deviate from free market orthodoxy and conclude that the stock market is really stupid. After all, those humongous deficits and tax increases are about as secret as Kate Gosselin’s new gig on Dancing with the Stars. Maybe now is the time to sell all your equity holdings before the market figures out what a mess things are and crashes.
Yet, one thing's for sure: stock indexes keep rising. That favors the incumbent party. If the market continues to be so friendly toward the Democrats, expect the fall elections to be contests.
The stock market and the conservatives can’t both be right. If conservative, free market economists correctly propound that stock prices rationally incorporate all public information, then the Democrats must be on the right path. Onward with health insurance reform, tax increases, etc. Otherwise, you'd have to deviate from free market orthodoxy and conclude that the stock market is really stupid. After all, those humongous deficits and tax increases are about as secret as Kate Gosselin’s new gig on Dancing with the Stars. Maybe now is the time to sell all your equity holdings before the market figures out what a mess things are and crashes.
Yet, one thing's for sure: stock indexes keep rising. That favors the incumbent party. If the market continues to be so friendly toward the Democrats, expect the fall elections to be contests.
Sunday, January 17, 2010
The Stock Market: Priced, Again, for Perfection
Last week, both Intel and J.P. Morgan announced earnings that significantly beat Street estimates. The market promptly dropped. What gives?
Analysts questioned the loan losses at J.P. Morgan; revenues were also below expectations. Intel's results generally drew praise. The problem, it would seem, is that the improvements at both companies didn't surpass expectations enough. In other words, hitting a home run isn't good enough these days. To see your stock price rise, you have to hit a grand slam home run out of the park, beyond the parking lot and across the street. One doesn't have to delve into the world of whisper numbers and other market rumors to understand what's going on. Just look at the price-earnings ratio.
The price-earnings ratio for the S&P 500, based on trailing earnings, is 70.79 (see p. B4, The Wall Street Journal, Jan. 16-17, 2010). This is way, way, way higher than the historical average of 15. A p/e ratio this high means that investors expect tremendous improvement in earnings or that we have a deliriously bubbly market. Or both. (See http://blogger.uncleleosden.com/2009/12/warning-from-price-earnings-ratio.html.) Whatever the case, it's clear that the market is priced for perfection. Anything less than absolutely gorgeous, gem quality financial reports from bellwether stocks like Intel and J.P. Morgan, and the market will start getting butterflies in its tummy. If this seems familiar, think back to the market peak in 2007, when the Dow topped 14,000, or the tech stock peak in early 2000.
After rising 60% in six months, the market has risen only 4% or so in the last three months. The bull is tired after its long run. Most analysts predict high quality earnings reports this month. But will that be enough? A p/e ratio of 70.79 sets the bar at stratospheric levels.
Some gamblers think that if Scott Brown, the Republican candidate in the Massachusetts special election for senator (to replace the late Ted Kennedy) wins, the market will take off in the belief that a Republican victory will kill health insurance reform and constrain federal spending. If you want to bet on this play, make sure you have your stop loss orders in place. The Democrats can work their way around the loss of a 60-vote majority in the Senate by having the House approve the Senate version of the reform bill or by rushing a compromise bill through the Senate before Brown can be sworn in. Neither alternative would be easy, but both are more palatable to the Democratic leadership than a failure of health insurance reform. The Democrats misjudged the voter sentiment in Massachusetts. But their problems with control of the Senate and the threat it poses to health insurance reform now have their full attention. Be cautious about betting your money on the Democrats making more mistakes.
You might want to get stop loss orders in place anyway. Even if Martha Coakley, the Democratic candidate for senator in the Massachusetts special election, wins, the late Republican surge sends a loud and clear signal to the Obama administration to hold the line on deficit spending, something the administration cannot ignore with the fall mid-term elections approaching. Whether or not the economy needs more stimulus, it won't be getting much more, if any, from the federal budget.
Of course, there's always the monetary printing press at the Federal Reserve, which recently installed showers and bunkrooms for the employees working 'round the clock. But even the Fed, which in the last 15 years hasn't met an asset bubble or an inflationary threat it didn't like, will eventually realize it's pushing on a string. The banks the Fed has been subsidizing are sitting on top of their very cheap federal funds instead of lending them out, while maintaining myriad unbooked losses (with the help of a politically coerced relaxation of accounting standards last year), reporting the resulting "earnings" (it's amazing how well a bank will do if loan losses are unbooked instead of booked), and paying really big employee bonuses. The Fed has avoided triggering inflation because the banks have avoided lending out their federal assistance. They hoard it against the need to book more loan losses. Since the funds don't circulate, they don't trigger inflation, but they also don't stimulate economic activity. That doesn't bode well for a stock market priced for perfection. Caveat emptor.
Analysts questioned the loan losses at J.P. Morgan; revenues were also below expectations. Intel's results generally drew praise. The problem, it would seem, is that the improvements at both companies didn't surpass expectations enough. In other words, hitting a home run isn't good enough these days. To see your stock price rise, you have to hit a grand slam home run out of the park, beyond the parking lot and across the street. One doesn't have to delve into the world of whisper numbers and other market rumors to understand what's going on. Just look at the price-earnings ratio.
The price-earnings ratio for the S&P 500, based on trailing earnings, is 70.79 (see p. B4, The Wall Street Journal, Jan. 16-17, 2010). This is way, way, way higher than the historical average of 15. A p/e ratio this high means that investors expect tremendous improvement in earnings or that we have a deliriously bubbly market. Or both. (See http://blogger.uncleleosden.com/2009/12/warning-from-price-earnings-ratio.html.) Whatever the case, it's clear that the market is priced for perfection. Anything less than absolutely gorgeous, gem quality financial reports from bellwether stocks like Intel and J.P. Morgan, and the market will start getting butterflies in its tummy. If this seems familiar, think back to the market peak in 2007, when the Dow topped 14,000, or the tech stock peak in early 2000.
After rising 60% in six months, the market has risen only 4% or so in the last three months. The bull is tired after its long run. Most analysts predict high quality earnings reports this month. But will that be enough? A p/e ratio of 70.79 sets the bar at stratospheric levels.
Some gamblers think that if Scott Brown, the Republican candidate in the Massachusetts special election for senator (to replace the late Ted Kennedy) wins, the market will take off in the belief that a Republican victory will kill health insurance reform and constrain federal spending. If you want to bet on this play, make sure you have your stop loss orders in place. The Democrats can work their way around the loss of a 60-vote majority in the Senate by having the House approve the Senate version of the reform bill or by rushing a compromise bill through the Senate before Brown can be sworn in. Neither alternative would be easy, but both are more palatable to the Democratic leadership than a failure of health insurance reform. The Democrats misjudged the voter sentiment in Massachusetts. But their problems with control of the Senate and the threat it poses to health insurance reform now have their full attention. Be cautious about betting your money on the Democrats making more mistakes.
You might want to get stop loss orders in place anyway. Even if Martha Coakley, the Democratic candidate for senator in the Massachusetts special election, wins, the late Republican surge sends a loud and clear signal to the Obama administration to hold the line on deficit spending, something the administration cannot ignore with the fall mid-term elections approaching. Whether or not the economy needs more stimulus, it won't be getting much more, if any, from the federal budget.
Of course, there's always the monetary printing press at the Federal Reserve, which recently installed showers and bunkrooms for the employees working 'round the clock. But even the Fed, which in the last 15 years hasn't met an asset bubble or an inflationary threat it didn't like, will eventually realize it's pushing on a string. The banks the Fed has been subsidizing are sitting on top of their very cheap federal funds instead of lending them out, while maintaining myriad unbooked losses (with the help of a politically coerced relaxation of accounting standards last year), reporting the resulting "earnings" (it's amazing how well a bank will do if loan losses are unbooked instead of booked), and paying really big employee bonuses. The Fed has avoided triggering inflation because the banks have avoided lending out their federal assistance. They hoard it against the need to book more loan losses. Since the funds don't circulate, they don't trigger inflation, but they also don't stimulate economic activity. That doesn't bode well for a stock market priced for perfection. Caveat emptor.
Thursday, January 7, 2010
Jobs Growth May Not Reduce the Unemployment Rate
The stock market eagerly awaits tomorrow's unemployment numbers. Economists, on average, predict that job losses will have stopped, but that jobs growth hasn't resumed. The unemployment rate, last reported at 10%, is expected hover around that level, with perhaps a minor increase.
This data, whatever it turns out to be, will probably tell us less than the stock market seems to think it means. Employment levels must be viewed in a dynamic context. The labor force keeps growing, whether or not there is a recession. Kids reach adulthood, and immigration continues (although it's now at a much lower level because of the recession). To deal with population growth, we need 100,000 new jobs a month or more simply to keep the unemployment rate level. It's been close to 2 years since the number of jobs in the U.S. has increased. Even if it turns out that job growth has resumed, the unemployment level could increase if the number of new jobs isn't enough to accommodate the entry of new workers into the labor force.
Aside from population growth, another confounding factor is the return to the labor force of discouraged workers. The Bureau of Labor Statistics includes unemployed persons in the labor force only if they have actively sought work during the last 4 weeks. Those who want jobs but are too discouraged to look for them aren't counted in the labor force. In other words, increased despair lowers the unemployment rate. Conversely, as the economy swings back toward recovery, discouraged workers may become hopeful again and start actively searching for jobs. Those that do so are deemed to have re-entered the labor force, and their re-entry can worsen the unemployment rate by increasing the numbers of unemployed persons actively seeking work.
The stock market is always looking for short cuts, simple ways of telling if things are getting better or worse. But economies and financial systems are complex and sometimes opaque. Life is difficult. Monthly unemployment figures are sometimes revised in subsequent months. You need to look at a lot of data and information to figure out where the economy is and where it is going. Don't read too much into tomorrow's unemployment numbers. Invest for the long term.
This data, whatever it turns out to be, will probably tell us less than the stock market seems to think it means. Employment levels must be viewed in a dynamic context. The labor force keeps growing, whether or not there is a recession. Kids reach adulthood, and immigration continues (although it's now at a much lower level because of the recession). To deal with population growth, we need 100,000 new jobs a month or more simply to keep the unemployment rate level. It's been close to 2 years since the number of jobs in the U.S. has increased. Even if it turns out that job growth has resumed, the unemployment level could increase if the number of new jobs isn't enough to accommodate the entry of new workers into the labor force.
Aside from population growth, another confounding factor is the return to the labor force of discouraged workers. The Bureau of Labor Statistics includes unemployed persons in the labor force only if they have actively sought work during the last 4 weeks. Those who want jobs but are too discouraged to look for them aren't counted in the labor force. In other words, increased despair lowers the unemployment rate. Conversely, as the economy swings back toward recovery, discouraged workers may become hopeful again and start actively searching for jobs. Those that do so are deemed to have re-entered the labor force, and their re-entry can worsen the unemployment rate by increasing the numbers of unemployed persons actively seeking work.
The stock market is always looking for short cuts, simple ways of telling if things are getting better or worse. But economies and financial systems are complex and sometimes opaque. Life is difficult. Monthly unemployment figures are sometimes revised in subsequent months. You need to look at a lot of data and information to figure out where the economy is and where it is going. Don't read too much into tomorrow's unemployment numbers. Invest for the long term.
Tuesday, January 5, 2010
Why 2010 Could Be a Tough Year for Wall Street
Most investors dislike volatility. When the market drops, stomachs churn. When the market rises, stomachs again churn if you missed the pop (as did many individual investors). If you bought on the way up, the ride is exhilarating--until it stops. And the damndest thing about markets is that they invariably stop rising at some point, and then fall.
On the other hand, Wall Street loves volatility. When stocks and bonds swing up and down, investors buy and sell them. That means commission income, and markups and markdowns, for brokers.
Volatility also provides trading opportunities, and the more volatility there is, the bigger the opportunity. The great housing collapse of 2007 gave hedge fund manager John Paulson the chance to make $15 billion for his investors, and over $3 billion personally. The next year, 2008, he reportedly made another $5 billion for his investors betting against big banks. His trading ability was crucial to spotting these opportunities. But the outsized volatility in housing prices and bank stocks enabled him to make gargantuan profits.
The big Wall Street banks often try to profit from volatility through proprietary trading--i.e., trading as principals. Goldman Sachs is famously skilled at this, and it's no accident that Lloyd Blankfein, Goldman's current CEO, came up through the ranks of the proprietary traders. Goldman has done well as a principal trading the ups and downs of the last three years.
Few prognosticators predict 2010 to be volatile. Most expectations for the economy range between modest growth to a double dip recession late in the year. Not many money managers are making glowing promises to their clients about the stock market, and the bond market seems murky more than anything else. Real estate may trend up slightly, or it may drop some more. No one really knows. Taken as a whole, the weight of current prognostications seems to indicate a muddled picture, with some asset classes moving up a bit and others down a bit. Assuming this to be true, Wall Street won't have the trading opportunities to hit the home runs of recent years. Hedge funds may struggle to stay ahead of the S&P 500. The big banks may have more modest returns than they did in 2009.
A year of pedestrian operating profits could prove tough for the big banks. They continue to hold many billions of hinky assets from the real estate crash, the credit crunch and the recession--CDOs, commercial real estate loans, defaulting credit card debt and so on. With the economic recovery slow, the banks will likely have to take more writedowns on these old lending mistakes. And there's always the risk of a new crisis in 2010. A major sovereign debt default (say, Greece or California) could dampen investor appetite for risk and highlight the virtues of holding cash.
Some believe commodities will be the big play in 2010. John Paulson and other money managers reportedly are betting on gold. But if the world's economies are truly recovering, they will pull up the fiat currencies against which the gold bulls are betting. And nobody expects a big jump in oil prices. One wonders if the recent reports of a brief cutoff by Russia of Belarus' supply might not have been someone in the Kremlin figuring on giving prices a little fillip.
If 2010 is a year without volatility, investors will breath easier. But Wall Street will probably make less money. With the ghosts of a lot of bad loans still haunting the Street, that could make it a tough year for the banks.
On the other hand, Wall Street loves volatility. When stocks and bonds swing up and down, investors buy and sell them. That means commission income, and markups and markdowns, for brokers.
Volatility also provides trading opportunities, and the more volatility there is, the bigger the opportunity. The great housing collapse of 2007 gave hedge fund manager John Paulson the chance to make $15 billion for his investors, and over $3 billion personally. The next year, 2008, he reportedly made another $5 billion for his investors betting against big banks. His trading ability was crucial to spotting these opportunities. But the outsized volatility in housing prices and bank stocks enabled him to make gargantuan profits.
The big Wall Street banks often try to profit from volatility through proprietary trading--i.e., trading as principals. Goldman Sachs is famously skilled at this, and it's no accident that Lloyd Blankfein, Goldman's current CEO, came up through the ranks of the proprietary traders. Goldman has done well as a principal trading the ups and downs of the last three years.
Few prognosticators predict 2010 to be volatile. Most expectations for the economy range between modest growth to a double dip recession late in the year. Not many money managers are making glowing promises to their clients about the stock market, and the bond market seems murky more than anything else. Real estate may trend up slightly, or it may drop some more. No one really knows. Taken as a whole, the weight of current prognostications seems to indicate a muddled picture, with some asset classes moving up a bit and others down a bit. Assuming this to be true, Wall Street won't have the trading opportunities to hit the home runs of recent years. Hedge funds may struggle to stay ahead of the S&P 500. The big banks may have more modest returns than they did in 2009.
A year of pedestrian operating profits could prove tough for the big banks. They continue to hold many billions of hinky assets from the real estate crash, the credit crunch and the recession--CDOs, commercial real estate loans, defaulting credit card debt and so on. With the economic recovery slow, the banks will likely have to take more writedowns on these old lending mistakes. And there's always the risk of a new crisis in 2010. A major sovereign debt default (say, Greece or California) could dampen investor appetite for risk and highlight the virtues of holding cash.
Some believe commodities will be the big play in 2010. John Paulson and other money managers reportedly are betting on gold. But if the world's economies are truly recovering, they will pull up the fiat currencies against which the gold bulls are betting. And nobody expects a big jump in oil prices. One wonders if the recent reports of a brief cutoff by Russia of Belarus' supply might not have been someone in the Kremlin figuring on giving prices a little fillip.
If 2010 is a year without volatility, investors will breath easier. But Wall Street will probably make less money. With the ghosts of a lot of bad loans still haunting the Street, that could make it a tough year for the banks.
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