Orchestrating the Sunrise

This edition of Musings finds us weighing the possibility that March 9 demarked the Bottom for the Generational Bear Market of 2007-09. The Market’s stunning 20%+ advance off of that day’s nadir has been made up of a very impressive combination of panic-stricken advances interspersed with pauses and pullbacks of decidedly mild temperament. As compared with previous rallies, it is eerily strong. I strongly suspect that we are now in the beginning of a recovery. Not as in, a few months from now we will look around and it will be like nothing ever happened, but a coming in off the ledge from which it was all too easy to imagine an interminable slip-slide into post-Postmodern squalor. In this edition, I will attempt to unpack a few thoughts as to what has caused this seeming sea change, why perhaps the moment we have just experienced might be called the Panic of March 2009, albeit a panic of a different sort.

The first item on the agenda is to remind you of the truism that whatever caused the Market to turn all but certainly wasn’t what the “accountability journalists” at AP, Reuters and DJ are serving up as explanations. I am not sure the editorial impulse to use the modifiers which inflame rather than enlighten is really any more so than twenty years ago. I am pretty sure, though, that the Market isn’t suddenly on steroids because this week’s Plan-From-On- High is somehow more credible than all the other plans that preceded it. However, as we shall see, there is a huge clue as to what Mr. Market has most likely figured out being carried along on all that hot air.

The starting point in understanding why the Market suddenly went up is found in the simple fact that it was ready to go up and waiting for a plausible excuse. This sounds almost inanely simple, but having watched it open and close many thousands of times, I know that this bespeaks the dynamic that matters most when one is considering short term fluctuations. On March 9, the Market was roughly 55% off of its late 2007 peak and down nearly 30% from a peak it realized on January 6. (Feel free to go look up how many of the preceding 20 or 30 trading days had been down.) It was, to be sure, an extreme condition, awaiting just a glimmer of warmth for the seeds of its opposite to burst into life.

The other, price reality related factor that you need to keep in mind is that every trend has its followers, and followers end up being patsies. During the bull market of ten years ago, there was the “buy the dips” crowd. It worked great, until one day it didn’t work at all, and many if not most gave back all they had made and then some. When the trend is broadly and gut wrenchingly down, the trend followers are short sellers. Not every short seller is an idiot, but we are certainly into that well-remarked process whereby innovators give way to imitators and then to idiots. What seemed like found money, maybe even the exception to the “no place to hide” lament that defined 2008, has suddenly turned into a nightmare. All those stocks up double digits on March 23, do you think that’s a sudden improvement in the commercial prospects of the entity represented by the stock? Of course not, its speculators suddenly becoming aware that risk cuts both ways, and other speculators who are aware of how eagerly they would like to cover their shorts. Short sellers are every bit as susceptible as the rest of us to misplaced trust in the fruits of their analyses, and equally if not more inclined to let herd-think take over. It is quite likely that during the prior week some of them were doing the mirror image of “buy the dips”. The education of some of these erstwhile geniuses, not to mention the cold hand of Darwinian career counseling (a.k.a., thinning the herd of the slow, the obdurately stubborn and the just plain unlucky) will be providing much of the fuel for the rally that I suspect will be the defining feature of the rest of 2009.

So what provided the glimmer of light that gave license to such wanton bouts of “bid ‘em up!”? Those possessed of that creeping form of cynicism that comes with years of having to tune into the seamier side of the Great Game will quickly gravitate toward that wink and nod given by the Chairman of the House Financial Services Committee at roughly the exact moment the Bear turned tail. (Cynicism is an occupational hazard to be resisted as well as one can. While I seem to keep it under control most of the time, recent developments have been sorely tempting.) There just might be something to the idea that politicians who take money from the likes of Fannie & Freddie and then act like it was no big deal might not be above taking money from other deep pockets for whom an inkling of a clue to a pending change in policy would be extremely valuable. I choose not to go there, not so much because it is an unprofitable exercise but because there are more compelling explanations.

For weeks on end up until the Market’s first upward surge, we were being treated to volumes of scary-making talk of transforming our experiment in ordered liberty into an amalgamation of Chicago and Berkeley, with a sprinkling of Havana thrown in. Control of both Houses suggested that “get it all in a hurry” was going to be unstoppable. The thing is, it only seemed that way. What occurred to me as that buying stampede wore on was echoed a few days later in the WSJ by Mr. Karl Rove. He noted that every Administration starts with political capital, which they inevitably spend. It’s just a matter of time, and some spend it much more quickly than others. I can remember when Reagan had basically spent his c. 1986. It occurred to me that this time, the collective efforts of this crew had thus far been so amateurish, so evocative of Commencement Day at Clown College and so presumptuous of success as to perhaps set a land speed record for blowing one’s political wad. One of the reasons the Market didn’t seem to mind that which was objectionable about the Clinton Administration was that it, too, rapidly squandered its ability to render things like “health care reform” and had to spend the rest of its years triangulating and otherwise playing it safe. The Market doesn’t seem to mind nickel-dime changes that actually happen so much as the prospect of Big Change with even bigger and grossly unknowable unintended consequences. One also senses enormous tensions building up among the acolytes and variously sordid hustlers who are impatiently awaiting a payback for helping bring all this into being, the sort of tensions that invariably corrode the efficacy of the endeavor. The wheels might not have come completely off of the Hope-N-Change Express, but I think we have heard at least a few lug nuts clattering down the highway. The Market has breathed a sigh of relief that all that talk of radical change looks to be just that, a lot of talk. Damage will be done, to be sure, but nothing like what was in mind as pundits were setting their sights on DJIA 5000.

But if the Administration is proving to be less than the paragons of pragmatic omni-competence that their media enablers made them out to be, how will the economy ever get better? This gets us closer to the heart of what has been going on: the “outrage” over the AIG bonuses. However, a digression is in order. If familiarity breeds contempt, “outrage” has been so overused as to become an exceedingly contemptuous word. It is almost as bad as “toxic”. Toxic means poisonous, something that will harm you if you touch or ingest it. Assets cannot do harm unless they are somehow inseparably tied to liabilities that might balloon in size beyond the value of the assets. So-called “toxic assets” are not at all toxic, they are simply of momentarily indeterminate value. To the extent they are mortgage backed, most of the mortgages are paying something, and virtually all of the underlying properties are worth something. Innumerable deep pockets are going to get very much deeper to the degree they can buy these so-called toxic assets at prices set by those who have succumbed to the hysterical chorus of “toxicity”.

Now back to the “outrage” over the AIG bonuses. One conversation I have no use for is with respect to the “fairness” of who gets paid what, both within Wall Street and with respect to Wall Street versus the rest of the world. That some people get what they do for what they do can be rationalized, but it is not worth attacking or defending. Children, this is one of those areas where life simply is not fair; never has been, never will be. So why the “outrage”? Is a bunch of sharpies receiving what amount to retainer fees for doing damage control on a mess they might have had a hand in creating any more ethically challenged than, say, the wife of a Senator being paid $350K to be a “diversity coordinator” in an inner city hospital (What does a diversity coordinator do, recruit persons of pallor to come work there?) How about an ex-President racking up nine digits in less than a decade to fatten his personal vanity fund, making the going rate for a night in the Lincoln bedroom look like chump change? Am I the only one who has a problem with this? The so-called “outrage” over the AIG bonuses has been so contrived, so predictable that it is obviously a smoke screen for something else. Perhaps it is something obvious, like similarly distasteful greasing of palms at more politically protected venues like Fannie, but maybe its something a lot less obvious than that.

What’s really going on here can probably be found by thinking through the question of “Where did the money go?” Not the bonus money, the taxpayer money that went into AIG. We read breathlessly indignant reports that it went to other entities that got bail-out money. What does this mean? It means that the financial crisis is well along in being whittled down to where the prospect of its failure will no longer impede the deep pocketed speculators who want to profit by panic on the part of nearly everyone else. AIG exchanged the cash they got from the government for some of their liabilities. Those liabilities were all some counterparties’ shaky assets. In doing so, AIG winds down toward being a collection of some not bad assets, no longer worth more than the sum of the parts, but profitable nonetheless. The counterparties end up with an upgraded mix of assets. They take the cash they received and clean up some of their liabilities (which have already been written down) that are someone else’s shaky assets. Rinse and repeat cycle until what was once a filthy mess is a stain that is just discernable enough to remind you to steer clear of similar messes.

I think what the political class has signaled by their use of this smokescreen is their panic over the prospect that “fixing the economy”, one of the things we have seemingly been programmed to count on for “them” to do for “us”, has started to happen and that they might not be able to take credit for it. As with all those recessions that happened before there was even a Federal Reserve, panics eventually get better on their own. This one is starting do so as well. Politicians might not be too smart in some respects, but they do tend to have a genius for recognizing when to jump on a bandwagon. Heaven forbid that this crisis melts away and no one takes credit for saving the rest of us. So we get a lot of noise, a lot of “restoring confidence” that will be obligingly recounted by the acolytes in the media a couple of Novembers from now. All because in fact an actual restoration of confidence is happening by quiet dribs and drabs in the arcane reaches of the credit markets anyway. It is as if by waving arms, mumbling incantations and sacrificing a virgin or two we can make the moon come back after the eclipse. I’ve heard it referred to as orchestrating the sunrise.

As I have noted before, we had a fitting climax to a nearly decade long Bear Market late last year. That was without reckoning with a resurgent political class feeling the need to put it’s imprint on the outcome in ways that could serve to extend its hold on power. Nothing I have seen makes me think that we are in for a return a “normal” reminiscent of 2005 any time soon. Expect instead a dreary but nonetheless upward sloping slog, and a Market that climbs a wall of worry. The problems have not all gone away, but the ones that threatened to undo the financial system have spent their fury and are on the mend. The Omni-competent Ones have shown their feet of clay, as well as their willingness to trip each other up. They will do damage, but nothing like investors had been dreading, and mostly to themselves and their future prospects. Stay tuned.