A Weak Pretext for an Overdue Correction

 We finally seem to be getting the correction we've all been waiting for.  The stage was set by that long, drawn-out "gosh, does this thing have an intermission?" symphony of feel-good announcements that reached a crescendo with the Fed's meeting notes on Wednesday afternoon. Twenty or so minutes later, though, the thought kind of sunk in, "Okay, now what's gonna make stocks go up?" and indices quickly showed us how badly this young Bull needed to take a breather. The improving unemployment claims report the next morning sent the Bears scrambling, but this only lasted until the report on existing home sales came out. This particular statistic is about as shaky a figure as you can hang an excuse to buy or sell on, but in the Market's present condition it was good enough to get the correction back underway.

The headline "reason" that the Market rolled over was a surprise 2.7% drop in existing home sales, to a seasonally adjusted 5.1MM. This was said to be a "surprise" because it had been up for four months in a row. Understanding just how weak a pretext for a sell-off this is starts with the "seasonally adjusted" element of the statistic. Its been more than a few years since I did so, but if you take a peek at what goes into seasonally adjusting activities like home sales, you will know how foolish it is to put any weight on a single data point (unless the change is a whole lot bigger than 2.7% of the annualized level of activity). There is simply not enough actual information in this "data" to tell if home sales are actually slowing down. 

Even if we grant some validity to the statistic as an indication of slowing, this should hardly be a surprise. I can think of two things that should be happening right about now that should be like a tap on the brakes for home sales. The first is that we are probably reaching the end of what was a buyers' market of a lifetime for housing. Beyond what amounts to subsidized mortgage rates and the tax credit for first time buyers, we also had legions of despondent sellers sitting on a mountain of inventory. Down another 10.8% in August, to a not unreasonable 8.5 months supply, the glut isn't what it used to be. It is probably not unthinkable then that at least a few sellers are no longer dancing a jig at the thought of someone, anyone, making an offer on their cash sucking albatross. As a market becomes less distressed, we should expect at least some transactions to drag out to include negotiation between parties who are on much more equal footing than it seemed six months ago. It is, no doubt, still a buyers' market in most markets out there, but "desperate and highly motivated" is becoming at least a little fewer and further between.

It is also likely that the rate at which home sales close has slowed because the real estate industry probably got caught flatfooted by the recovery. This industry (think of it as all those purportedly indispensable folks who seem to line up with their hands out when you want to buy or sell an home) had to shed a lot of capacity in a hurry last year. Should we be surprised that a genuinely surprising upsurge in the number of folks looking to re-finance or maybe take a flyer on a re-po or whatever caught them by surprise? So maybe by August it took longer to close a deal than it did before the recovery started getting noticeable. A few extra days for loan approval would definitely move the needle on a thirty day period of activity, even without the effect of annualizing.

So throw in the bonus thought that maybe Cash for Clunkers soaked up a bit of buying power, or at least consumer "bandwidth",  and we should hardly be surprised if the recent fire under home sales cooled a bit in August. A sane and experienced individual would not dump equities because of this bit of non-news, but a Crowd certainly will. We have seen even weaker "reasons" than this one "explain" inflection points. The aforementioned symphony of encouraging news has indeed taken a brief intermission. You do not want to be out in the lobby when the music starts up again. 

The Power of Wishful Thinking

This Market is crazy, but no crazier than we've seen it before. Experience all but dictates that it is overdue for some kind of meaningful correction, in time if not in price, but it keeps on levitating. I find myself thinking really hard about taking money off the table. Indeed, I have let a few marginal, legacy holdings go and have written some calls against some stocks I would lighten up on if they "get there by then". The resurgence in the animal spirits, though, is so  remarkable that it is hard not to just let it ride. What's up with this?

What's up is the asymmetry of those two prime drivers of Price Reality, Fear & Greed. Most investors fail to grasp that Bull Markets are not all about Greed and the Bear counterpart all about Fear. Both fear and greed are always at work. In a Bear Market, fear is most evident, but the greed of short sellers is also a factor. This was much less evident from the 1930s until hedge funds emerged in a big way, bringing formidable intellectual firepower and capital to the short side of things. It certainly helped things along during that Crash we all just lived through. The issue at hand is the overlooked fears that are turbocharging resurgent greed in the early innings of this Bull Market. I suspect that for every player who is bidding up stocks because they have recently become greed-addled there are at least a few others who are operating in more of a fear mode. There are the aforementioned short sellers. I can personally attest to what it feels like to have started shorting stocks because the Market has run a long ways in a hurry. In 1991, having watched an unleveraged account rise some 60% in a matter of months, my attempts to "take advantage" of the Market being "ahead of itself" resulting in such unforgettable moments as having 1000 shares HWP open 15 points against me one morning. Believe or not, this did not cure me, at least not right away! More recently, short selling was so easy for so long, and then it wasn't, and an awful lot of bright young things have gotten the same sort of education. Some of them are slow learners, though, so their bouts of renewed confidence followed by the panic of being "wrong again" will continue to add fuel to the melt-up until all but a few of them are either long gone or gone long.

Fear would also describe the mindset of those who are being held to relative performance benchmarks and have prudently been taking some profits and waiting for a pullback. Such a proper and ultimately profitable way to strategize over the long term, but oh so difficult to execute a day at a time when the feedback is so powerfully against you. "Inevitable" (as in "inevitable correction") has a way of taking its time. There is also the more widely experienced "fear of missing out". Bring all these fears together, and blend in a quickening sense of just how contrived the Street Theater that rendered a normal correction into a once-in-a-generation blowout actually was, and we should not be surprised to see price recovery that makes as little sense as the capitulation of thirty or so weeks ago. 

The Greed side of the equation does not yet smack of, say, late 1999, but it too has an element that is less apparent than what we think of as greed (i.e., an excess of natural acquisitiveness). I have observed in the past that most investors have a built in tendency to assume unrealistic rates of return on their life savings. This is simply because for most investors (all but the very rich and those with little or no capacity to save) life, both in the present and in the future, looks a whole lot rosier if you assume a double digit return on your savings than if you assume something closer to the risk-free rate. What indulgences you can afford today, and how worry-free your post-wage-slavery days will be tend to be astronomically greater if you assume, say 9% returns over time rather than at, say, 4.5%. This is not about the difference between skinflints and spendthrifts, this is about the freedom to make a few high-utility choices at the margin, both in the present and prospectively. So the money flows that bid stocks up are in large part driven by a bias to probably-not-realistic returns that can persist for a very long time.

With the exception of initial positions in an oil refiner and the preferred stock of a property manager, I find myself in the "waiting for the next pull back" mode. My year to date returns would be a pretty good four years, realistically speaking, and part of me wants to raise cash every day. Right now, though, the part that recognizes that the unnatural seeming strength of buying conviction out there is not so unnatural after all, says "Let it ride". 

 

9/11: Never Forget

It's hard to believe it has been eight years now since that morning when, as I was settling in at my office (a few blocks from the Hudson River about 140 miles north of NYC) I noticed the sound of a jet aircraft that was much louder than the normal, inbound to ALB, traffic I would often hear. This was followed by an early conference call that usually had extensive Q&A but ended after just one question besides my own, and then hearing about what sounded like just another bad day for general aviation ("an inexperienced pilot ran into a building, no doubt"). Fast forward a few hours to me stopping at a church I had been getting out of the habit of visiting and then not only praying out loud (so not like me!) but then hearing later from some co-workers about how it ending up on local TV! And then a couple of days later, completely losing my temper, something that has only happened once or so a decade (at work anyway) over what in hindsight was a mere slight inflicted by the buffoon then masquerading as our Director of Research. (It was as if the rage stirred up in me by the 9/11 attack had pushed things up to within about a half a degree of the the boiling point, and one dumb-ass little memo was all it took to unleash Berserker.) 

Time heals wounds, but not completely, it would seem. We can forgive, if grace is a part of who we are, and sometimes forget, but sometimes not. There is a concern out there that We the People are starting to forget what was made plain on that dreadful day. This was certainly helped along by the semantic mischief of recent months whereby the "War of Terror" was banished from official discussion, as if a millennial struggle had in a couple of years gone from white hot to stone cold. There is indeed a current within our vast and variegated culture that would like to Move On, to revel in fatuous utopian notions and transform this day into some kind of flower planting, mural painting inter-generational Amerikorps, but its not very wide and not very deep. For most of us, the visual horror, those amazing pictures of impact,collapse and humans astride the threshold of doom, reach through the windows of our souls and strike places that were rendered permanently tender. If, in the years just ahead, we are somehow visited with another terroristic attack, the pain of brushing up against this wound on our collective soul will swiftly transmute into outrage. 

9/11/01 is memorable not only because of the horrific attack and the heroism of that day but also because of it briefly transported us out of the stultifying bubble we had assumed was reality. We learned much to our delight, that ennui, that postmodern "whatever", had not gotten the better of us after all. It had been tempting to suppose that following the trajectory of every civilization that had preceded us, we as a people had reached a point of irreversible diminishment, too comfortable and self-satisfied to stand up and fight, if necessary. For a moment (actually, a few months, and then the numbness of affluenza reasserted itself) it was palpably evident that rumors of our demise had been greatly exaggerated. There is something much more resilient in our national character than we are normally able to recognize. We saw it eight years ago. We see it in the way the economy is stirring back to life after the global financial panic of a lifetime, and have seen it in the way a lot of citizens responded to the overreaching of Powers-that-be of the moment on the matter of dramatically tampering with the delivery of health care. This sacred day still brings a pain to my heart and a glisten to my eye when I let some of the photographs transport me back, but it also reminds me that virtue lurks beneath the surface of our national persona, well cloaked by the banalities of what passes for popular culture, but alive and capable of vigor nonetheless.  

Presidents Day

Conservative critics of the president's televised address to young scholars across the land need to take a deep breath and calm down. When one's adversaries seem to be making it a habit of doing things that make one wonder whether they are crazy or stupid, that's a good thing. The adversary I have in mind is not the president himself but the team assembled around him. Some kind of inspirational address to mark the first back-to-school of his administration might have been done in a benign enough way to make whoever criticized it seem shrill. That was my first thought, a little rhetorical jujitsu that turns an overly aggressive assailant's energy against him. Dispensing a dose of platitudes of the Just Say No variety would hardly be unprecedented, nor out of line with the way electronic interconnectedness has evolved of late. But instead of keeping it as simple as an old-fashioned spoonful of cod liver oil, somebody got the bright idea to trick the whole exercise out with lesson plans, etc. This had the effect of sending out yet another blast of confirmation that we are being governed by a gang that can't seem to shoot straight. It is hard, watching how things have played out since about the time that CrapNTrade cleared the House, not to wonder if somebody somewhere is trying to lull the opposition party into a sense of overconfidence. 

One can certainly sympathize with concerns about parental notification and "going around" school districts, but viewed in the light of prospective outcomes, this little episode is all to the good. Am I the only person who has found himself wondering if any of these bright young things who think this stuff up have ever been around any actual children? It is likely that some child somewhere will be nudged in the direction of progressive ideology, but based on the kids I have known I would expect an opposite effect. For every future ACORN "volunteer", expect the faux sincerity of this exercise to inoculate at least a dozen young citizens against the blandishments of the Nanny State. To the extent any of them are actually paying close enough attention for the message to actually sink in, I would expect it to plants seeds of dissonance. Most kids are smart enough to recognize the phoniness of telling someone you never met how much you care about them; if not now, it will sink in eventually for all but the most thickheaded of them.

The nerve that is being struck here ties in with something I have observed over the time I have been aware that there was a President. Back when JFK made his "Ask not.." appeal, we used to celebrate and learn about the lives of two remarkable individuals who happened to have been Presidents. We learned about the character, trials and triumphs of Washington and of Lincoln. That they both served as the chief executive was secondary to what they were as men. Then somewhere along the way, to neaten up the calendar one supposes, we woke up to Presidents Day. The effect, to the degree anyone thinks about this day as anything but a pretext for sales and a day off from work, was to shift the focus from a couple of individuals of exemplary character to the office itself. Washington and Lincoln were inherently worthy of respect. The fact that a person got himself elected, maybe not so much. 

Viewed in the light of how the whole experiment was cobbled together in the first place, this devolution is at least faintly distasteful. Now fifty or so years after JFK made his appeal (at a time when there was scarcely a rural county or urban neighborhood that had not recently shared in the ultimate form of sacrifice for one's country), the Keystone Cops in charge think its a good idea to ask kids to write down how they can "help Him". This is creepy, so much so that once again, they do themselves more harm than good. 

 

Time to Heal, Time to Deal

Summer is now for all practical purposes over, and the "summer rally" of 2009 is very much a thing of the past. For a month already, we have actually been in a state the old time technical analysts called correcting in time. The actual rally was 2+ weeks starting when Intel kicked off that long string of better than expected earnings reports. It only took the Market a dozen or so sessions to amend its previous error in judgement, rash emotional creature that it is, and price its constituent parts as if most of them have a future after all. It has been marking time ever since, in a mode much like it was in for about six weeks leading up to the aforementioned catalytic data point. The news continues to be, on balance, quite encouraging, but an economic recovery that is anything short of perplexingly robust is already in the price of stocks. 

At times like these, most investors are either fretting about or hoping for a big pullback in stock prices. We have gains that we are not 100% confident won't melt away in the next Market downdraft, and there are stocks we wished we had bought when the fire sale was on, but didn't, or only bought nominal amounts. (One needs to learn to live with the fact that an investor can never do enough of a really right thing.) What most investors don't seem to understand is that however "ahead of itself" a Market like this might seem, there is no rule of nature that says that it has to go lower for a time before it can rally further. We might have a catalytic event which triggers a sell-off of greater magnitude than the 2-3 day, 2-4% variety we have seen along the way, but it will probably have to be "event driven". Stocks never go in a straight line for very long, and do indeed tend to get ahead of themselves (in either direction). The remedy for this is called "correction", and can occur in time (i.e., a stint of aimless meandering) as well as in price. 

Considered through the lens of seasonality, this past week should have been a snoozer. In terms of the slight net decline for all five trading days, that would seem to be the case. A day at time, though, market action was anything but somnolent. It had opened the previous Friday in a state that left it badly in need of a breather. A spate of "concerns" cropped up over the weekend to facilitate a sharp drop over the next dozen or so trading hours. The action on the last two days before LD Weekend, days which more so than nearly any other are dominated by the kind of money that doesn't rest, strongly suggested that if the path of least resistance has any kind of slope to it, it continues to be upward. That said, I expect the Market to continue to correct in time, i.e., go more or less sideways over the next several weeks. Q3 earnings releases will likely further validate the non-demise of global economic activity, but whatever recovery is likely to occur in that slice of future that is discountable by the Market is already pretty much in there. We will likely see some lively days in anticipation of the earnings season, but with nowhere near the effect that was rendered in late July. 

My sense is that the driver of any kind of meaningful short term gains is in the late stages of shifting away from "anticipating economic recovery lifting all but the most waterlogged of boats" and towards deal heat. After a very long dry spell, M&A activity seems to be perking up. We should not be surprised that both buyers and prospective sellers have shied away for the past two years at least. That seems to be changing, however. Capital markets have definitely come unstuck. Deals can be done, and after such a long hiatus, deals definitely will be done. The private equity crowd has been transfixed by the prospect of participating in the next wave of bank consolidation, eager to waddle up to a trough reminiscent of Resolution Trust Company circa 1992. That the rules of engagement for this subsidized bacchanalia have been worked out at a pace akin to the effects of the Stimulus package has kept this bit of wealth redistribution in neutral, but that is about to change. At the very least, the boys will be able to decide how much to allocate to this bit of taxpayer largesse, which will clarify how much "dry powder" will be available for other adventures. 

Over the rest of 2009 and probably into next year, M&A activity will be in something of a catch up mode and so more or less constantly in the headlines. This means that during this time period, which will likely be followed by a meaningful correction in price as well as time spanning a good part of 2010, the performance of one's portfolio is likely to be all about take-outs and revaluations premised on transactions involving similar companies. Stock picking will seem to matter much more than just being in stocks, which has been the most important thing since the tide turned six months ago. A more honest understanding of how one fared in the last third of 2009 might be garnered from the old maxim about how its better to be lucky than smart. Either way you want to account for it, I see deals and the ripples they produce as the thing that will for any given investor determine whether 2009 was an exemplary, or merely good, year to have owned a pile of stocks.