Pump and Dump

April 25, 2009

Finally, a crack in the hope rally.  But it was only a small crack:  the S&P500 dipped about half a percent for the week.  The VIX, or the fear index, jumped for the first time in weeks, also supporting the pullback.

The green shoots arguments lost some ground this week:  leading economic indicators at -0.3% was worse than predicted; Initial claims at 640,000 and continuous claims at 6.14 million were also worse than expected.  Durable goods orders were still negative (month to month) and existing home sales dropped much more than expected.

The technicals also crossed over, mildly from bullish to bearish this week, on the daily charts.  The equity markets are still extremely overbought and are overdue for a more meaningful downside correction.

This week, Bloomberg published a interesting piece on insider selling within the NYSE listed companies.  After an impressive period when the S&P 500 climbed 26% from a 12 year low on March 9, company insiders sold 8.3 times more equities than they bought. 

Per Bloomber, that represented the fastest rate of selling since October 2007–the all-time peak of the S&P 500, and the beginning of the current devastating bear market. 

Also, the $42 million of insider purchases (through April 20) represents the lowest amount of purchases since July 1992.

Given that the last major selling wave signalled the last major peak in the equity markets, and given that we have recently reached a strong technical market high, what can we conclude from this current burst of insider selling?

Alan Abelson in Barron’s asks the question this way: “If those now infamous shoots of recovery are popping up all over, why would insiders be aggressively dumping stocks?”

His blunt conclusion: “Nobody ever sold a stock because they thought it would go up.  And as a group, corporate insiders obviously are scarcely enthusiastic about the prospects for a genuine bull market.”

One can argue that many forces came together to pump up equities over past six weeks, but regardless of the particular means and reasons, it sure looks like the insiders are dumping them now.

Perhaps you should too.

Going Out on a Limb

April 19, 2009

Although decelerating, momentum pushed up the S&P500 yet another week–this time by 1.5%. 

Economic fundamentals did not improve, as usual.  Housing starts and permits–whose bounce in March provided some of the reasoning behind the recent green shoots propaganda–resumed their downward trek.  Producer prices and consumer prices fell; in fact, the CPI’s -0.4% yoy decline was the first annual decline since 1955, certainly not supporting a rebound in economic activity which would typically push up CPI on a yoy basis.

Also, retail sales dropped in March, which was totally unexpected:  consensus estimates called for an increase.  Industrial production fell by more than projected and capacity utilization fell to the lowest level on record.  Initial claims stayed elevated (in the 600K range) and continuous claims rose to yet another all time record: 6.02 million.

Technically, the S&P is now even more oversold than last week, and setting itself up for a short trading opportunity.

The Standard and Poor’s top-down analysts regularly update their forecasts for S&P500 as-reported earnings.  Over the last two years, the accuracy of their forecasts has been notably higher than the consensus of the bottom-up analysts who typically have a long bias because their firms often sell the products (stocks) they analyze.

The Standard and Poor’s most recent projections for 2009 and 2010 as-reported earnings for the S&P500 are $29 and $35, respectively.  So at the current price of the S&P (870) and using the higher of the two projections for earnings ($35), the P/E ratio is 25.

Now 25 doesn’t seem too high when compared to the trough P/E’s from 2002 and 2003 (also about 25), but we’re not dealing with your typical recession today.  Instead, we’re living through the mother of all asset and credit bubbles–and we’re not anywhere close to the end of the storm.

Arguably, therefore, we must look to other more secular (not merely cyclical) bear market lows to put the current P/E ratio into context.

In the 1970’s, the 1950’s, the 1940’s and the 1930’s, the P/E of the S&P bottomed out at well below 10. 

So today, if we apply a P/E ratio of 10 (and not lower) to the $35 earnings projected for the S&P in 2010 (and not the lower earnings projected for 2009), then it becomes perfectly plausible that the current S&P valuation might risk leaving some investors feeling like they’ve gone out on a limb.

Worse than a Lie

April 12, 2009

Just like the Energizer Bunny, this rally is still going.  Although it’s weakening, the upside momentum pushed the equity markets up again:  the S&P moved up 1.7% in a holiday shortened week.

Fundamental data was still weak:  initial claims were at 654,000; continuous claims hit 5.84 million (another record); consumer credit plunged; trade collapsed; and the treasury budget for 2nd quarter of the FY rang up a deficit of almost $200 billion–also a record.

Corporate earnings for Q109 got off to a poor start: Alcoa missed by reporting losses that were worse than expected.  And the next two weeks promise to deliver a storm of grim results and weak outlooks–especially in the non-financial sectors which the recession has now slammed into.

Technically, on a daily basis, the rally is becoming extremely overbought.  And it shouldn’t take much–in the form of news–to spark a meaningful pullback.  The test will be whether critical former levels, like 750 on the S&P, will hold.

On a monthly basis, the bear market is still fully in effect, and in no imminent danger of ending.

In this week’s Barron’s, William Black, a veteran regulator from the S&L crisis of the 1980’s (and now an economics and law professor) made some bold and startling assertions about the Obama administration and its handling of the current financial crisis.

When asked about the approach taken by the administration, he stated: “we have failed bankers giving advice to failed regulators on how to deal with failed assets. How can it result in anything but failure?”

Speaking of the PPIP plan to remove toxic assets, Mr. Black said: “It’s worse than a lie…..The current law mandates prompt corrective action, which means speedy resolution of insolvencies.  [Geithner] is flouting the law, in naked violation, in order to pursue the kind of favoritism that the law was designed to prevent.  He has introduced the concept of capital insurance, essentially turning the U.S. taxpayer into a sucker….He chose this path because he knew Congress would never authorize a bailout based on crony capitalism.”

And summarizing the credit crisis, he states: “With most of America’s biggest banks insolvent, you have….a multitrillion dollar cover-up by publicly traded entities, which amounts to felony securities fraud on a massive scale.”


Aside from ruining his presidency, Mr.Obama, according to Mr. Black, will ruin the economy. 

Let’s hope he is wrong.

America: The Great Ponzi Scheme

April 4, 2009

The bear market rally continues.  Although it showed signs of weakness (after dropping sharply the day the Obama administration announced its latest auto industry bailout plans), it closed up over 3% by the end of the week.  At this level, it has bounced up from the early march lows as dramatically as it did during the 1930’s, the last time we suffered from a colossal asset and credit bubble bust.

The main theme behind the rally is the idea that things are getting less bad.  This second derivative reasoning assumes that, if the market looks far enough ahead, today’s slower rate of decline in the economic data portends the eventual rebound that must surely follow.  Perhaps.

Not all of last week’s economic data looked less bad.  The Case-Shiller housing index actually reported an accelerating rate of decline in the prices of homes, falling at a 19% yoy rate.  The ADP employment change, at -742,000, was the worst of this crisis, to date.  Initial claims jumped to 669,000–the highest since 1982; and continuous claims rose to 5.73 million.  Nonfarm payrolls came in at a worse than expected -663,000.  And the unemployment rate jumped to 8.5%, the highest since 1983.  Both Chicago PMI and ISM services were also lower than expected.

Not very encouraging, but the equity markets didn’t seem t0 mind.  For now.

The current issue of The Economist highlights the development path of a capitalist economy:  at the end of the path, it blows up as a consequence of its prior success.  A leading economist  from the mid-1900’s, Hyman Minsky, argued that as an economy grows in size and drives down unemployment, it tends to create an overabundance of confidence.  This leads to the problem where borrowers eagerly take on too much debt and lenders become blind to the risks of providing it.  The result is that asset bubbles, in housing, in equity securities and even in debt securities, develop. 

Borrowers end up borrowing more, against appreciating collateral, just to pay the interest on the rising debt levels.  Later, borrowers take on a level of debt that exceeds the value of the collateral; they borrow so much, because everyone anticipates that collateral values will rise enough to be able to pay off the debt.  Debt levels, as compared to total income and compared to total collateral values, soar to dizzying heights.

Then something pops.  Often a small incident can start a violent process of reversing the bubble growth.  Borrowers start to default, and collateral values plunge as borrowers (and lenders who take possession) rush to sell, putting even more downward pressure on prices. 

This process describes what happened in the U.S. and much of Europe over the last 25 years, especially in the housing markets.  Our economy created a massive house of cards that led to the illusion of massive wealth creation. 

This was a giant Ponzi scheme.  And because it took 25 years to create, the consequences are ominous:  it will take years to correct, and it will be a large correction.  So we have a long way to go.