Friday, May 15, 2009

The Bogus Stock Market Rally

We all hear (ad nauseam) that "stock market is a forward indicator," which as an observation ranges between meaning very little and being absolute BS. During the early years of the Great Depression, the stock market often "indicated" things were going to get better -- and, mostly, they got worse. Remember the old mantra called "Buy and hold." Those of us who adhered to it learned it actually meant, "Buy and hold until you go brankrupt. Then, make sure your best friend is named . . . Tim Geithner."

The people who most passionately advocate the "forward indicator" theory are those who are . . . selling stocks. The recent rally has consisted mainly of a rise in bank stocks, as well as -- one guesses -- the manufacturers of vats of red ink for sale to banks. Here's how the assesses the "recent rally."

"Admittedly, the stock market can resemble the oil markets of a year ago when oil price went steadily up with no rhyme, reason, or connection to supply and demand. (They went up because speculators sold oil This Rally Is Ridiculous "futures" to each other at stratospheric prices, until they all got onto one another's scams and prices collapsed.)

"I realize the market is a discounting machine -- with investors collectively trying to anticipate future events and price shares accordingly -- but let's face it: This rally is getting ridiculous. Wall Street is on a bender (yet again), and the shiny, happy future it seems to be looking forward to overlooks the fierce grimness of now. It's a mirage, at least in the near term. Maybe the midterm, too.

"You may be right; I may be crazy.

"Still, it's worth pondering just how much longer this particular bout of irrational exuberance might last. If the market can make it here, after all, it can make it anywhere.

Unemployment is high and poised to climb higher; GDP has famously fallen off a cliff; and the much ballyhooed news that consumer spending rose during the year's first quarter (hurrah!) evaporated on contact with even just casual analysis. January produced virtually all the quarterly gains; February was flat; and March actually saw consumer spending decline. (Boo! Hiss!)

"And yet the market has been on a tear, with the S&P 500 climbing by some 11% during the month of April alone. And guess -- just guess -- where the bulk of those gains have come from? Why, from financial stocks, of course, with the sector posting a 22% rise over the period.

Black hole sun

"This particular mirage is a mesmerizing doozey, with the likes of American Express (NYSE: AXP), Wells Fargo (NYSE: WFC), and Capital One (NYSE: COF) rocketing to gains in excess of 30% over the period.

"And this despite the fact that the black hole at the center of our financial galaxy remains, with toxic assets sucking liquidity out of the credit markets just about as fast as government largesse can pour it back in.That, however, is a temporary "solution" (right, elected officials?).

"And unless someone pulls a rabbit out of a hat soon, gallingly, it may be the banks themselves that shoot this one down.

"And why not? Our apparent willingness to prop 'em up into perpetuity has yet to be seriously challenged, which explains the financials rally. Rumors of profitability have been greatly exaggerated (thanks in part to mark-to-dream-on accounting), but when the U.S. taxpayer is your compulsory patron, it is, as the kids used to say, all good. Indeed, we might as well call it rational exuberance.

History repeats?

"With that as a backdrop, it's worth asking whether financial-stock multibaggers can be far behind, even from their currently inflated levels. Based on its closing price last Thursday, for example, seemingly beleaguered AIG (NYSE: AIG) would be a 10-bagger by returning to "just" $11 a share, a price it exceeded as recently as last September.

"Don't get me wrong: I don't believe such a rocket-shot would be warranted, at least not based on fundamentals. Indeed, I'm among those who believe that the financial sector should return to its former lack of glory, becoming a comparatively much smaller slice of the market's pie chart, complete with permanently shrunken market caps for former big boys.

"Between now and that smaller, shabbier future, though, there may be money to be made, largely by speculators betting that the financial sector will essentially become a government entitlement program -- albeit one that puts up with little of the pesky regulatory oversight that attends, say, Medicare or Social Security."

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