Scary Season

All Hallows' e'en finds us looking back on a week that was frightful enough already. As scary making as the action in most of my stocks has been over the past two weeks, we should not be surprised. That a Russell 2000 ( RUT, the index that best exemplifies most of my holdings) should drop nearly 10% in two weeks is perfectly understandable in light of its having levitated 80%+ in the preceding seven months. What we are going through is a lot like what happened in May, June and into July. After a rip-roaring 7-8 weeks through the end of April, the indices basically went sideways for more than two months. The Q2 earnings season found stocks good and ready to respond to a positive catalyst. This time, the Market anticipated the catalyst, frustrating those prognosticators who assured us that September was synonymous with sell-off. The fabulous earnings reports were like a shot of caffeine late into an arduous day, keeping it going through the motions, but to no productive avail. As in the June correction, when the major indices fell peak to trough nearly 10%, the RUT a little more than 10%, the RUT peaked a little earlier. It is now lower than it was on August 1. So to the extent that that element of Price Reality we call "correction" is about time as well as price, we are actually well along in the process.

As always, the Talking Heads find it necessary to come up with substantive reasons why gravity has finally set in. Many of them seem to appear every time the indices dip for more than a day or so to pronounce, one more time, the end of the "sucker rally". It has been my experience (which is starting to become considerable) that there is real wisdom in the maxim that Bull Markets climb a wall of worry. There will be abundant reasons for the Market to roll over and play dead all the way up. Why should 2009 be any different? We hear and read a whole lot of what looks like confusing cause and effect ("The dollar sold off, so investors bought commodities, which..") Who the Hell knows?!  The concerns voiced about how much of the strength in technology spend is inventory rebuild is legit, but probably overdone as a result of forgetting that the "pipeline" is just a metaphor. One wonders about what it would be like to have followed the Tech Sector for the past ten or twenty years. It seems likely that they all have been conditioned to just "know" that if it's good news, it won't last. There is no gainsaying just how cyclical these markets have been since silicon started to stand for something besides beaches and big boobs. So what if big parts of what we call Tech evolved down the same road as autos, airplanes, tractors and trucks (in their early decades both life-changing and wildly cyclical, but eventually less cyclical and more rational)? Would the analysts whose insights seem to determine sentiment at the margin, conditioned by their experiences of the past decade or two, be able to recognize it? I am inclined to expect a wild but ultimately very fruitful ride here.

One common theme that we keep hearing in many of these gangbuster earnings reports which could be causing some heartburn is how much help these earnings got from marked down labor and materials. This is the result of last year's abrupt shift from sellers' to buyers' markets, a fortuitous condition for consumers that is simply not going to last. Users of all kinds of commodities benefitted from a brief period when their suppliers went from hoarding to trying to raise cash, and deals could be had. Similarly, we saw not only a great deal of cost reduction in the form of lay-offs (quite a few of which would have been untenable at any other time in this litigious age) but outright wage & salary reductions as well. (If this was happening in past downturns, I missed it.) These, too, will be reversing in the quarters just ahead. Indeed, there is a whole lot of "offset to inflationary pressures" in the cost of all kinds of things that will probably start to go the other way next year. This adds not only margin pressure against earnings but the specter of outright inflation to our Wall of Worry.

One other thing that the Market is probably holding its breath over is the referendum to be held on Tuesday, November 3. It's a piddling little off-year election, but it will speak volumes about how HopeNChange is going down with the folks who care enough to show up and vote. It feels like piling on to point out how despite the huge imbalance in campaign spending, that the outcome in a state like New Jersey should hang on the impact of a third candidate is not exactly positive feedback for the In party. The Mandate is more or less dead in the water. Its centerpiece, Health Care reform, which our Fearless Leader wanted done by the August recess, has morphed into a 1,990 page political tar baby (like the trickster edifice of folklore, sensible politicians see that they embrace it at their own peril). Expect to see a whole lot of bobbing and weaving, of "we gave it our best shot but the evil obstructionists played dirty", hopefully followed by some bipartisan efforts to effect some badly needed incremental reforms. 

To the extent this referendum forces the Administration to act more like the Clintons post-1994 (somewhere between gridlock and triangulating) a stultifying uncertainty will be abated. That would be the way most small business owners must be feeling right now. In addition to the usual uncertainties faced in a cyclical downturn, these key decision makers are facing a set of moving pieces that mostly boil down to "how much is this going to cost me?". Now it must be admitted that the Administration has done a splendid job of at least one thing. That would be demonstrating that running a successful campaign does not necessarily translate into the competence to govern. As I noted as early as February, their accomplishments will fall well short of their agenda, but damage will be done. We might not be getting the structural changes we worried about, but for the entrepreneurs who, for example, have pay to have OSHA, the wildlife biologists et al weigh in on how they resurface the parking lot, it is a dreary slog, with miles to go. Intrusive government is inflationary not because it unbalances the budget but because it causes producers to say, "To Hell with this, it's not worth the aggravation. I'm done!" and there goes another piece of the latter half of the equation that understands inflation as "too much money chasing too few goods". This genuinely worries me. It's what made the Seventies so "special". Hopefully, the referendum at hand will clear some of this up. If not, there will be a somewhat more comprehensive one in about 365 days.