The Geithner Factor? Ha!

This edition of HRVA finds us, once again, none too thrilled about living through a moment of historic import. We are not referring to what some are calling 11/4, when the “the seas stopped rising” and all that, although that does play into this morning’s funk in an indirect sort of way. No, this past week took the Market indices to depths that will rank this Bear Market somewhere between “73-74” and The Big One in the 1930s. (Apparently, there were at least three distinct Bear Markets in that era, a 48% drop in just over two months in the fall of 1929, a similar drop over a one year period starting in 1937, and the Granddaddy of them all, the 86% drop between April 1930 and July 1932.) As of the morning of November 21, no Bear Market except the 1930 debacle has been worse than what we have now gone through (Those who were long the Tech Bubble going into 2000 and didn’t get out might beg to differ.) The spirited rally that marked the last hour on Friday might have lifted our spirits a bit. It was the media explanation that this time-worn observer of human folly found exasperating.

There are two explanations for why the media informed us that the Market broke loose from a pattern of meandering uncertainty and ripped about 6% in an hour or so. The one I would prefer to believe is that, as always, certain peoples’ meal tickets are dependent on coming up with reasons why inscrutable activities happen. Apparently consumers of information and insight expect an explanation for whatever is happening in the moment, and if one wants to keep their snout in the trough from whence investment insight is generated, they sure better come up with an answer. So like when the sun comes up its because the geese just flew by (or in another time and place, that first born male child got passed through the fire), the fact that the name of the likely Treasury Secretary was leaked around the time the Market took off was a slam dunk in the great game of spurious cause & effect. Never mind that having been crumbling the way it had all week it was as oversold as it ever gets. The media and the Street do this all the time, as if there was a possibility that if just once they did not have a glib answer for the day’s fluctuation, we might tune them out and not come back.

A less palatable explanation might be that the news media is still smitten with our newly arrived Savior and eager to do their part in helping Him make history. The announcement of the name of a likely Cabinet member does clear up a bit of uncertainty, but only a small bit. How much might this glimmer of clarification account for, say, the 12% rise in the value of Microsoft that afternoon? As a conservative (one who is squeamish about the prospect of squandering what the Founders bequeathed to us) it has been disconcerting to watch the institutions that have are supposed to hold the political class accountable show such abject adoration for any public figure, let alone one who has shown strong sympathy toward the thoroughly discredited ideologies that brought so much human misery to the Twentieth Century. It will not be a good thing if even the financial media is in the tank for the Anointed One and his crew of nice folks from Chicago. One is left to hope and pray that the opposition can buy time, rebuild and rise again as voters recognize life starting to resemble the aftermath of the Great Society again. In the very near term, though, there could be a silver lining in this. To the extent that the Market is very over ripe for some kind of rally, and “needs an excuse to go up”, this sort of cheerleading could prove helpful in weeks and months just ahead.

Most likely, what transpired Friday was that the Market got a just good enough “excuse to go up”. Any excuse would have done. The Nasdaq had traded down nearly 55% from its year earlier peak as of Friday, the S&P 500 about 52%, the DJIA just shy of 50%. The whole week had been disheartening, the final hours of the two preceding days in particular. The economy, which has been slowing for quite some time (the global purchasing managers index peaked over two years ago), got pole-axed by the shock waves emanating from financial markets in September. It might not start to recover until well into next year, and when it does start to recover it could be a very tepid recovery for quite some time. That said, it is important to never lose sight of how short term pricing activity almost invariably exaggerates what is actually going on in the world of commerce. And we have got the illustration of a lifetime of this from the recent price of petroleum.

Recently, when called upon to try and be helpful to younger colleagues, I find myself encouraging them to think of investing as the reconciliation of two distinct realities. There is the reality of the enterprise that underlies the stock, which I call Commercial reality. We need to devote most of our time, effort and thought to understanding this reality; to being assured that the enterprise we are investing in has a strong commercial position and can hang on to it. It works itself out in intrinsic value, which can be quantified, but only approximately so. The other reality is what I call Price Reality. It is about fear and greed, momentum and sponsorship, and while it can be precisely measured in whatever the price is in a moment of time, it can only understood for what it is, a manifestation of the mood of an ill-informed and emotional crowd. I try to encourage colleagues to view what they do this way, as an alternative to succumbing to the Analysis Delusion. This is a tendency to build models and then treat those models as somehow real in a way that exists outside the mind of the person who made the model. Models are useful tools, but not much more, and in the hands of someone who disregards what really real, they become implements of destruction.

With this in mind, consider what has happened over the last year or so to the price of something that is much more a part of how nearly everyone on the planet goes about their daily business than those abstractions that, figuratively speaking, change hands every day on the NYSE. It is hard to remember just where a barrel of oil was priced a year ago, but $60 in 2007 would not be off the mark. Indeed, I have dim recollections of $60 seeming kind of “out there” no more than two years ago. Somehow, it found its way up to $147. Then, perhaps ninety days later, it’s breaking through $50. Somehow, the stuff that makes the trucks run and the planes fly and puts the ester in your polyester, among about a zillion other things we don’t want to think about living without, lost two-thirds of its value in about a dozen weeks. It is true that many of us have found ways to drive a bit less, and likely that economic activity will continue to slow to an extent that some price retrenchment might be in order. Any fool could tell you as much. Many of us “knew” there was something in the realm between fishy and ridiculous about it going to $147, that the “speculative interest” was acting in a way that was contrary to the interest of the rest of us. Studies were made and experts hauled before committees, but the outcome was the familiar “I didn’t do it, nobody saw me, you can’t prove anything!”

Thus it will always be. Markets are peculiar things. People want explanations, as if they were as forthcoming as what the research of the past 200 years has rendered in fields like chemistry or astronomy. Such answers about why stock prices do what they do are not forthcoming, and never will be. Part of the reason is that most people seem to so prefer answers that merely seem substantive and they reject answers that leave that matter in the realm of mystery. (Mystery in the sense of how so much else, like weather or the workings of the body remained mysterious, until science provided a bit of illumination. Despite being much more understood, these matters also retain a bit of mystery.) Markets act the way they do because humans are, to varying degrees, speculative creatures, endued with an impulse to better their lot in life by making guesses about an inscrutable future. Speculation is always with us (as long as there is freedom, and even in oppressive states there will be covert markets). Most of the time, it is benign, even useful activity. Occasionally it takes on a life of its own and becomes a raging beast. We have just lived through such a time. This will be remembered as one of those times when speculation became the “tail wagging the dog”. Actually, this is the time when the natural consequence of that abnormal state, a painful unwinding of excess, takes place. Hopefully, this unwinding has found impetus from the rapidly approaching New Year. If it is things like tax loss selling and client redemptions that have kept the selling interest so much greater than the buying interest, we are now only a couple dozen trading days away from when that is no longer the case. Let us hope so.