Asset Values: A Look At The Stock Markets

Over the past year, I have spent a lot of time discussing the problems created by falling house prices and the effect this has on debt levels and personal solvency. Falling house prices have placed many owners in the uncomfortable position of having no equity or negative equity in their homes.

Recently, I wrote a post considering the economic value of small businesses and the impact this is having on the sales of these organizations.  The falling valuations of small businesses have put many owners in a similar position where the equity they have in their businesses has become rather small or has even become negative. (http://seekingalpha.com/article/279506-debt-deflation-and-the-selling-of-small-businesses)

Today in the Financial Times, financial manager and author Andrew Smithers provides us with a look at the valuations attached to larger businesses as represented by their values on stock exchanges.  (See “The Conditions For The Next Crisis Are Firmly In Place”, http://www.ft.com/intl/cms/s/0/f1ff9be8-a3e5-11e0-9f5c-00144feabdc0.html#axzz1SZnxOYcr.)

His fundamental conclusion, the US stock market is “overvalued” and this connected with high levels of private sector debt point to a very precarious situation for the economy.  In the US, “private sector debt is 2.6 times gross domestic product, and nearly twice the level reached after the 1929 crash.”

His estimates of the US stock market: it is “about 60 percent overpriced.” 

Smithers comes to this conclusion using two well known measures of stock market valuation: the “q” ratio, “the ratio of market value of non-financial companies to their net worth, adjusted for inflation”; and CAPE, “which is the cyclically adjusted price to earnings ratio.”  (The “q” ratio was developed by Nobel-prize winning Yale economist James Tobin and CAPE was developed by current Yale economist Robert Shiller.)

He cautions about the use of the ratio in trying to determine market moves: “Value provides little guide to short-term market movements.” 

“If we are lucky, stock markets will not fall sharply for some time.”

The reason is that when corporations are strong buyers of their own stock, the stock markets stay buoyant.  In fact, “the US stock market has risen and fallen exactly in line with corporate buying.”

Thus, Smithers continues, it is important to “predict whether companies will continue to be strong net buyers of shares in the months ahead.”

A key predictive variable…whether or not companies have “relatively high levels of cash compared with their total debt levels”…which US companies currently possess. 

“Over the past decade, at least, cash ratios have been a leading indicator of equity purchases by firms.” 

But, Smithers warns about the near-record level of debt that corporations hold “whether measured gross or net of cash, and whether compared with net worth or output.”

He says that this fact is “startlingly at variance with the claims frequently made that US company balance sheets are in great shape.”  Smithers argues that the aggregate data are most important here and not the individual balance sheets.

It is here I differ with Smithers.  I have argued over the past year that the economy has split into two components...those companies that are in “good” to “great” shape and have a lot of cash on hand and have even borrowed at the excessively low interest rates to improve their cash positions…and those that are in “bad” to “terrible” shape.  The division is, in essence, between the “haves” and the “have not’s.”

Some big companies are in really good shape financially while many other large- to medium-sized companies are not in very good shape at all.  These well off big companies are “keeping their powder dry”, buying companies here and there, and also purchasing some of their stock.  The others…well…they are really struggling. 

This is one reason merger and acquisition activity has been so strong this year.

But, this situation is also one underwritten by the Fed with very, very low interest rates and quantitative easing.  The “haves” have it all!  The “have not’s” have next to nothing.

So far the Fed’s quantitative easing has kept the stock market going and part of this, as described by Smithers, has been the underwriting of the cash accounts of many of the biggest corporations which has led to a portion of the stock buybacks that have taken place.  (Further gains have been achieved by using the Fed’s money to go “off shore” and get into world commodity and equity markets. See http://seekingalpha.com/article/276909-federal-reserve-money-continues-to-go-offshore.)

Of course, the businesses that are not in “good” financial health cannot engage in these activities.

Thus, the big and better off are fed…and the others must scratch for their survival.

Other than this slight disagreement with Smithers, we can get back to the crux of the story.

The US stock market, according to the two measures discussed here, is overvalued by about 60 percent. 

We cannot predict the exact timing of market movements, but, historically, whenever these measures get so “out-of-line” there has eventually been a correction. 

Smithers places this correction out somewhere in 2013.  Why?  “It’s the first year of the new Chinese government, of the new European stability mechanism, and—most important of all—the first year of the new US government.” 

Wherever the “blow” comes from, corporate cash flows “will almost certainly fall sharply”

Consequently,Smithers asks, “If corporate cash flow drops, who will buy the stock market?”

My question is, “When will the large- and medium-sized firms that are not in good financial shape and that are overvalued have to sell?”  We have seen this phenomenon take place in real estate.  We have seen it take place with the smaller businesses. Given the analysis presented above, this phenomenon is going to spread over the next year or two to even the larger businesses.  And, with market values too high, acquisition prices will be below stock market values, hence the markets will fall.

This is something that fiscal stimulus and quantitative easing cannot offset.  It is a part of the debt deflation process that follows years of credit inflation. 

It's a High Frequency World

Gillian Tett raises some interesting questions in her Financial Times article today: “What can be done to slow high-frequency trading?” (http://www.ft.com/cms/s/0/d72966fa-bc2d-11df-8c02-00144feab49a.html)

She closes her piece with the most important economic question that can be asked: “To my mind, the real question which needs to be discussed—but which regulators are still ducking—is why ultra-fast trading is needed at all?”

The answer: people believe that they can make money if they have a slight edge in the speed at which they can make trades.

I don’t think that this answer is changed by going into the debate relating to the neurological research which argues that “the brain has two contradictory instincts: part of it is hard-wired to chase instant gratification; however, another part of our brain also has the ability to be ‘patient’, and delay immediate gratification for future gains.”

This is just the argument raised by the behavioral finance and economics researchers. (See my review of the book “Snap Judgment” for a discussion of this issue: http://seekingalpha.com/article/145660-book-review-snap-judgment-by-david-e-adler.) The general assumption that accompanies this train of thought is that “instinctional” behavior is irrational and therefore not productive.

To quote from Tett’s article, “in practice innovation…has a darker, impatient side too: as markets have become deeper, and more liquid, that has enabled trading to become more frenetic; similarly, as information has become more frequently available this has encouraged skittish, herd behavior.”

But, life is full of situations in which “instinct” or the ability to make quick decisions is of crucial importance. For example, we need military leaders that can make decisions “on-the-spot” as well as those that can plan out strategies for long, drawn-out battles. The military trains people over-and-over again to develop the perception and experience to make decisions in the “real time” that is necessary for winning battles and winning wars.

We can find examples in many fields where “immediate” action is needed. The education and training in these areas is intense and efforts are made to find the people that are the very best in their ability to diagnose a situation and come up with the “right decision” as often as possible.

The real difference is the capability of the person or persons making the decisions. In the military, in medicine, and in many other professions, there is a hierarchy in terms of who makes the decision. Hopefully, the people that rise to the top are those individuals that can perform well and are able to make good “snap” decisions if they are needed.

Sometimes there is licensing or other forms of identification that require test taking and hurdles to overcome in order to get the certification or advancement that will put the “right people” in the “right spot” for a specific type of “real time” decision.

In economics, these tests or hurdles are called “barriers to entry”.

In the trading of stocks and other investment vehicles, there are low barriers to entry into the industry and this includes the costs one must pay to enter an industry. As a consequence, there are many traders and not all of these have the “jet pilot” capabilities to execute trades at the speeds that are now available.

The crucial thing is that in areas where quick decisions need to be made, a premium is paid to those with the education and training, the experience, and the mental capacity to make such decisions. As I stated in the post cited above, successful decision making, over any time period, depends upon “cold analytical methodology and steely discipline, characteristics that most people, who rely too much on their instincts, don’t possess.” That is, some people are better decision makers than others, even in the very short run.

People are going to engage in an activity where they believe that they can make money. So high-frequency trading is going to take place. Individuals that cannot perform within such an environment are going to lose, and could lose a lot.

The concern of the other market participants is “what damage can these not-so-good traders do to the overall market?” As Ms. Tett states, one result of the move to high-frequency trading seems to be “more market volatility.”

The fear in this: “rising levels of speed, impatience—and short-terminism—might have actually made the (financial) system less efficient, and rational, than before” this increase in speed.

My feeling with this is that speed is something we are going to have to live with. I have argued this point before in my post “Banking at the Speed of Light”. (http://seekingalpha.com/article/208513-banking-at-the-speed-of-light) The point is that this “speed up” is happening all over the world in different kinds of decision making. It is just that high-frequency trading is getting a lot of publicity now and thus attracting a lot of debate.

In the post just mentioned, I cite the example of events happening in South Africa relating to the use of mobile phones by commercial banks to develop their customer base. In this example the discussion was around the 15 million adult South Africans that had previously been excluded from the financial system. And, the players in this effort are not small.

But, this points to another issue, the growing strength of the “new rising powers” in the world as discussed in an opinion piece in the Financial Times titled “The new disintegration of finance.” (See http://www.ft.com/cms/s/0/938e7228-bc55-11df-a42b-00144feab49a.html.) The authors, Stéphane Rottier and Nicolas Véron, are concerned about how the effort to organize and co-ordinate global financial regulation and supervision is facing issues that might reverse the trend to great co-operation. One of their concerns is that “Financial institutions from emerging countries are beginning to overtake their western peers. New financial centers are gaining market share, while emerging countries are asserting themselves in global financial rulemaking, and increasingly resist standards proposed by the member of the old north Atlantic consensus.”


This is the world of the future. This is how competition is going to progress. See “The New World Order: Smaller and Faster”, my post of August 31, 2010 (http://seekingalpha.com/article/223127-the-new-world-order-smaller-and-faster). I think most of you know how I feel about the ability of regulations to control this world. I think most of you know that I believe that many, if not most, of the big players have already moved beyond what American…and world…regulators are trying to do with respect to financial institutions and markets. Laws, regulations, and regulators must deal with processes and not “outcomes.” I have written about this many times in my posts.

Hold on, it is going to be an interesting and exciting ride!

More Talk About Credit Bubbles

Bloomberg put up a headline this morning that I found eye-catching: “Stock Market ‘Bubble’ to End, Morgan Stanley Says”, http://www.bloomberg.com/apps/news?pid=20601110&sid=a.YErMIwMYKA. Ruchir Sharma, who oversees $25 billion in emerging-market stocks at Morgan Stanley, is quoted as saying “the (global stock market) rally will end as the effects of the (government) stimulus begins to fade and the credit bubble caused by easy money disappears.”

We are still learning about asset bubbles and credit bubbles so it is interesting to examine what market participants are seeing and what they are saying about the existence of bubbles and the subsequent collapse of bubbles. In this reported interview we get some insight as to how one person sees the current situation in the stock market.

“Some markets may be hurt by the diversion of government stimulus away from the economy and into stocks and other investments,” Sharma states. “Central banks globally were hoping the funds would result in an increase in credit growth, driving the economy. That remains weak in most countries.”

“Liquidity has found its way to the wrong assets,” he said. “You can take a horse to water but can’t force it to drink.”

According to Sharma, what many have been talking about with respect to the United States economy is being seen around the world. Governments have spent large amounts of money attempting to stimulate their economies and the central banks in those countries have poured liquidity into their country’s financial system in order to get credit flowing again.

Rather than the funds going directly into the spending flow, increasing economic activity, the funds have circuitously found their way into “stocks and other investments.” The diversion of these funds into “stocks and other investments” have resulted in a substantial rise in asset prices in these areas, stock markets and commodities markets, and have left productive outlets wanting for resources.

How could this situation have evolved having just gone through three recent experiences of asset or credit bubbles, the stock market bubble of the 1990s, the “bull run,” according to Sharma, “between 2003 and 2007” and the housing bubble? Don’t the policymakers have any idea of the damage they can do to a financial system and economy?

In this respect, another person, Arthur Smithers, with a “deep understanding of economics and a lifetime’s experience of financial markets” (See Martin Wolf”s “How Mistaken Ideas Helped to Bring the Economy Down” in the Financial Times: http://www.ft.com/cms/s/0/38164e12-c330-11de-8eca-00144feab49a.html.) has also questioned current values in stock markets.

Smithers has used “two fundamental measures of value” to determine the “fair value” of markets. These two measures are the “Q” valuation ratio that was developed by the economist James Tobin and the CAPE measure, the Cyclically Adjusted Price Earnings” ratio developed by the economist Robert Shiller. (The “Q” data are available from Smithers own company, Smithers & Co, http://www.smithers.co.uk/, and the CAPE data are available through Shiller’s web site relating to his book “Irrational Exuberance”, http://www.irrationalexuberance.com/index.htm.)

Both measures relating to the stock market give off very similar signals. Each measure is indicating that, currently, the stock market in the United States is 30% to 35% overvalued.

According to Smithers, and as discussed by Wolf, being overvalued, even by this amount, does not mean that the market will immediately revert back to a more reasonable price. The market may not revert back to its more fundamental value for a year or more. But, it does return to more “justified” levels. Sharma also indicates that the markets he is talking about may not return to more reasonable levels for some time.

A reason why the value of the stock market may deviate from its fair value for an extended period of time? Government policy, especially monetary policy, may “inflate credit growth and asset prices.” And, errors in monetary policy can extend on for several years. (For more on this see the book “Wall Street Revalued” just published by Smithers. Also, you can read my review of this book on Seeking Alpha: http://seekingalpha.com/article/163499-imperfect-markets-inept-central-bankers-wall-street-revalued-by-andrew-smithers.)

Wolf summarizes the work produced by Smithers: “Imperfectly efficient markets rotate around fair value. Bandwagon effects may push them a long way away from fair value. But, in the end, powerful forces will bring them back.” In other words, bubbles always burst and the balloon always comes back to earth.

Another problem associated with bubbles like this is that resources are pushed back into the same old economic sectors that had been the focus of investors in the past. That is, physical resources are going back into industries that are less productive and less robust than what they should be going into. As Sharma is quoted as saying, “A new rally globally needs to be driven by new industry groups,” not the same sectors that led “the bull market that ended in 2007.”

This is exactly the problem that I presented in my posts of October 26, http://seekingalpha.com/article/168852-the-state-of-the-economy-the-good-news-and-the-not-so-good-news, and October 27, http://seekingalpha.com/article/169130-is-it-time-for-more-economic-stimulus. The trouble with trying to “force” the economy to grow and to achieve certain objectives that are important to the politicians, the economy does not grow and develop organically.

Thus, the sluggishness of old industries is re-enforced while the opportunities connected to new, more dynamic industries are retarded. The consequences are only seen later in slower economic growth and reduced increases in productivity. But, these problems are for another time, and the politicians don’t have to focus on yet.

A Quick Look at Profits

So far, two facts stand out to me in many of the current earnings releases. First, for many large financial firms, trading profits have provided almost all of the positive results that we have seen. Second, for many large non-financial firms, cost cutting has resulted in better-than-expected earnings.

Both of these lead me to the conclusion that the basic or fundamental businesses of the companies reporting are showing little or no life. In other words, the demand for the basic products or services they provide is listless, at best. And, results like these are not sustainable.

Yes, the results are encouraging. Profits are always better than losses. But, these profits are not connected with the core business of these companies and hence give no indication that either the financial firms or the non-financial firms have established some kind of competitive advantage that will last into an economic recovery.

In terms of the large financial firms, like Goldman Sachs and JPMorgan Chase, the trading profits have allowed them to post substantial earnings and get the government off their backs. Getting the government off their backs is important and will become more so in the future because these companies can pay to keep their top-flite executives or pay to attract other major talent to their organizations. They can buy time as their core businesses improve. However, trading profits are not sustainable and should not be counted over an extended period of time.

The large financial firms that have not produced, like Citigroup and Bank of America, will find themselves at a considerable competitive disadvantage, both in the United States and worldwide, as their competition can apply their strengths to continue to grow and increase market share. Plus, these non-producers are having to sell off assets like BOA’s sale of First Republic and Citigroup’s sale of Phibro even though both were profitable operations.

The last thing these organizations need is to have their pay the top officers receive drastically cut. Not only do troubled firms have problems hiring top talent, but to have the onus of the government hanging over the companies and controlling what top executives get paid is doubly bad. These financial institutions were too big to fail—immediately. But, they are not too big to fail a slow death. Certainly the government’s effort to impact the remuneration of the top executives at firms still receiving government help will skew the playing field to the Goldman’s and the JPMorgan’s.

One can understand in today’s environment that a lot of people are angry about big salaries and bonuses, especially to those that have been bailed out by the government. Certainly, the forthcoming big bonuses to be received by the executives at Goldman and JPMorgan do not help stem these populist attitudes about the pay at financial institutions. But, in this case, the response of the public is just helping the competitive position of Goldman and JPMorgan and hurting that of these other large banks because the actions on pay just makes Citi and BOA less competitive! Goldman and JPMorgan are smiling all the way to the bank!

The other banks, the regionals and the locals? They need time to continue to work out their loan and security portfolios. They need to regroup, get back to their core business and they will be fine. But, this is going to take time. Nothing substantial in profits here for a long time.

As far as the non-financial firms are concerned, their cost-cutting efforts are paying off. Their efforts to return to their core businesses are paying off. But, cost cutting alone does not produce sustainable exceptional returns. Cost cutting can be duplicated. And, as long as consumers stay on the sidelines and restructure their balance sheets and keep reducing their debt not increasing it, the final demand for goods and services will not show much bounce.

There is continued hope in one sector after another that sales will pick up. In computers. In retail sales. In food services. There is continued hope that sales will pick up during Thanksgiving, or Christmas, or at some other relevant time. But, these blips of hope seem to pass on as sales continue to disappoint. The hope is transferred to the next holiday.

Companies, for the past four or five months, have posted not-so-good earnings, but they raise their forecasts for the upcoming year.

There is nothing these companies are doing right now that produce sustainable results. Demand for their products and services must be forthcoming and, right now, there is little encouragement that this will happen any time soon.

All of these factors raise two concerns in my mind. First, what is the basis for the continued rise in stock prices. The profit results that have been achieved so far are not sustainable and point to no growth in earnings or cash flows for the time being. Furthermore, the cost cuts are great, they help companies get their focus back onto the right things. But, cost cutting does not result in a continued increase in earnings or cash flows. In addition, trading profits do not contribute to extended growth in earnings or cash flows. This is why I am concerned about the possibility that the rise in stock prices since March might just be a bubble. (See http://seekingalpha.com/article/167561-are-we-in-an-asset-bubble-or-not.)

Second, managements are refocusing their efforts and reducing inventories, labor, and other resources that they had accumulated during the go-go years. This restructuring, given past experience, will continue, even when the economy begins to recover again. These managements are not going to return to the same business practices as before. This will change the supply side of the economy and, as a consequence, full employment of resources will not be the same as it was earlier in this decade.

If this does occur, and I believe that it will, it will just be one more part of the trend that began in the 1970s. Through all the cyclical swings in the economy during the last forty years or so, the economy has never regained the height it had achieved in the previous upswing. That is, the next peak of employment, of capacity utilization, of industrial production, has never as high as it was at the previous peak.

This means that the economic policies of the last forty years or so have left more manufacturing capacity idle, more workers discouraged, and more resources wasted each cycle of the economy. The American economy is changing along with competition in the world. Artificial stimulus on the part of the United States government just tries to put people and other resources back into the jobs that they once held, like in autos and steel for example. And, such an economic policy only exacerbates the longer term trend. Furthermore, this is not helpful to the stock market.

It is easy to build a case that the rise in the stock market in the 1990s and the 2000s were asset bubbles created by easy credit. Given the performance of financial and non-financial firms at the present time could the Federal Reserve just be producing another one?

The Stock Market: A Bubble or Not?

Questions are now being asked about the nature of the rise in the stock market. These questions have to do with the reality of the rise, how high the market will go, and when will the economy produce results that are consistent with the optimism captured in the stock market rise.

There is another way to look at the rise in the stock market since March 2009: the rise could be just another asset bubble.

Asset bubbles are a form of inflation. As we have learned over the past fifty years, excessive monetary or credit ease can come out in one of three ways. First, there can be outright inflation. In this case, popular price indices, like the Consumer Price Index, can rise by inflated amounts. Second, prices of assets in one or more sectors of the economy can rise at a pace that exceeds the rate justified by the underlying fundamentals of the sector. Third, when the economy is facing supply side adjustments that constrain the healthy growth of the economy, excessive monetary or credit ease can force economic growth in areas that have declined in productivity. That is, the excessive monetary growth can force resources back into declining industries rather than allow them to adjust into the more productive areas of the economy that are in the process of expanding. In these cases nominal growth of the economy is higher than it would be otherwise and inflation is muted by the re-kindling of industries that needs to change or modernize. This results in a form of “stagflation” where we get the worst of both slow growth and masked inflation.

There is little doubt that the monetary authorities have pumped plenty of liquidity into the banking system. The year-over-year increase in the monetary base (currency in circulation plus bank reserves) has been increasing at a rate of around 100% for the past year. As yet, little of this liquidity has found its way into bank lending.

Still, the two basic measures of the money stock have shown year-over-year rates of increase that, historically, can be considered to be substantial. The M1 measure of the money stock has been rising for months in the range of 15% year-over-year, while the M2 measure of the money stock has been rising in the 8% range over the same span of months. Some of this growth can be attributed to a re-arranging of asset portfolios into more liquid assets. Still, all of this money is not sitting idle even though interest rate levels are historically low.

How might this expansion of the monetary variables be used? In the past, rates of growth like this would be considered to be inflationary. Yet, there is no evidence that spending on final goods has increased appreciably and, hence, the rate of increase of consumer prices has remained just above zero, year-over-year. There has been some growth of the economy and some of this growth can be attributed to areas where resources had been leaving (autos) to move to more productive operations. The government stimulus spending has produced a spike in output here and there but does not seem to have produced any sustained increases in economic growth. The possibility of stagflation seems to lie in the future. Therefore, it seems as if two of the three outlets for monetary ease can be excluded from the present analysis.

That leaves us looking for the existence of an asset bubble. Certainly the movement in the stock market since March is a good place to look for a possible asset bubble.

We certainly have some experience in stock market bubbles having just gone through the stock market bubble of the 1990s. Could we be having a repeat performance?

In terms of assessing this possibility I am going to turn to two measures of stock market valuation that were discussed in a book I recently reviewed. The book is titled “Wall Street Revalued” and was written by Arthur Smithers. The review can be found at http://seekingalpha.com/article/163499-imperfect-markets-inept-central-bankers-wall-street-revalued-by-andrew-smithers. The two measures are Tobin’s Q ratio and the Cyclically Adjusted Price/Earnings (CAPE) ratio developed by Robert Shiller. In mid-September, these ratios were already showing that the U. S. stock markets were 35% to 40% overvalued, and that was before the run-up that took the Dow above 10,000. (For a report on these numbers see http://www.ft.com/cms/s/0/b82d2b96-bc02-11de-9426-00144feab49a.html.)

Is the rise in U. S. stock markets a bubble?

Bubbles, of course, are easier to define after-the-fact than when they are occurring. But, the “Q” ratio and the CAPE have done a pretty good job historically of indentifying times when the stock market is overvalued.

If the stock market is overvalued right now because the Federal Reserve has created another asset bubble--it’s third in about 15 years—then the economic and financial situation in the United States is quite tenuous. The economy sucks, the banking system is still faced with major credit problems, and the dollar has fallen close to 15% since January 20, 2009. What kind of a policy can the government throw at this dilemma?

Any tightening to brake the expansion of the bubble and/or combat the decline in the value of the dollar threatens the solvency of the banking system and the fragility of the economic recovery. But, as we have seen over the past 15 years, bubbles eventually collapse on their own. Are there any “good” ways out of this situation?

This is not a pretty sight, but it is one we must take into consideration. As we continue to learn, though, once we lose our discipline, all the good choices in policy seem to disappear!

Uncertainty: The King of the Market and what to do about it

This is a time that is particularly conducive to impulsive or instinctive behavior. It is a time that behavioral economists love because it proves their case about irrational human behavior. People react and they react on the basis of a gut feeling or a snap judgment.

These researchers tell us that this type of behavior is what has helped the human species survive. However, it is not necessarily the kind of behavior that leads to decisions or actions that are in our best interest when investing. “Relying only on intuition in finance can lead to very bad outcomes, not only for individuals but also for markets.” (This quote comes from David Adler’s new book “Snap Judgment”: see my post that reviews this book, http://seekingalpha.com/article/145660-book-review-snap-judgment-by-david-e-adler.) Yet we humans, individually and collectively continue to perform in this way.

Right now, the concern is whether or not the economy is bottoming out and starting to recover. We get “green shoots” here, but then some other indicator of economic activity comes in worse than expected. Alcoa puts up better than expected loss numbers but retail sales come in lower than expected. Sales of existing homes improve yet we get wind of another wave of subprime mortgage problems. (See “Subprime Returns as Housing Woe,” http://online.wsj.com/article/SB124709571378614945.html#mod=todays_us_money_and_investing.) And, what about the problems in commercial real estate, credit cards, and Alt A mortgages?

Then there is the question about whether or not there should be a second round stimulus bill. Paul Krugman has argued for a long time that the first stimulus bill was not enough. Yesterday Laura Tyson indicated that she thought that there needed to be a second round. Now the debate is all over the place. But, wouldn’t another stimulus bill add more to the government budget deficit going forward? And, there are questions about the possibility that the government has already committed to too much debt.

So the Dow Jones average goes up from 6500 and looks very strong approaching 9000 and then goes into a swoon. The price of crude oil was approaching $40 a barrel in February and then shot up to above $70 but now has returned to the $60 range. The yield on the 10-year treasury issue was nearing 2.00% in December 2008, jumped up to around 3.90% in the middle of June and traded at 3.30% yesterday. An index relating the value of the dollar against major currencies was around 70 in July 2008, popped up to the mid-80s in March 2009 and has since declined to about 77.

When the economic indicators seem strong the price of oil goes up as does the stock market and the price of bonds and the value of the dollar decline. When the economy seems weaker we get just the opposite movements. And, my bet is that it is going to continue this way for a while. So, uncertainty, and hence volatility, rule the marketplace.

This is the short run. Recently, however, I have been writing more upon the long run, what deficits do to long term interest rates and to the value of the dollar. Over the longer run, historically, some patterns repeat themselves over and over again. This, of course, brings to mind the statement made by John Maynard Keynes, “In the long run we are all dead!” Still, we need to take the long run into account.

This is where we need to take heed of what the behavioral economists advise. We, as investors, must not rely on intuition or gut reactions. We must not over react to the environment we now find ourselves in. Research has shown that acting in this way is not necessarily in our best interest.

The research also indicates that investing based on fundamental economic reasoning does work. Therefore, it seems as if now is a time for discipline and hard work. And, it is a time for patience.

But, this does not mean that one needs to totally ignore the short run. It is perhaps impossible to expect that most people will just sit out this stage of the economic cycle and invest their funds in safe, low-yielding assets. So, what kind of strategy might work here? My suggestion is that one needs to segment one’s portfolio, allocating some money to playing in the current market volatility, but allocating a larger share of the funds to potential future fundamental investment choices.

The smaller part of the portfolio can be allocated to playing both sides of various markets. Obviously, getting into the market near a “bottom” would be very profitable, but selling short near a “top” would also work. But, by all means consider any investments here as short term in nature because it is highly likely that the “bottom” may not turn out to be a “bottom” at all. Likewise for a “top.” So, one must be very agile in investing this way. Don’t hang onto losses, but let gains ride. Behavioral finance tells us that people tend to operate in the opposite way hanging onto losses hoping for the best and quickly selling gains to have something to show for their efforts. This is where discipline and focus are crucial.

Furthermore, remember that, on average, the expected returns on trading are zero: and there are still fees that need to be paid. But, using part of your funds in this way keeps you “playing the game” while still keeping the major part of your portfolio available for “value” investing to take advantage of longer run opportunities.

As research has shown, the fundamentals do apply over longer periods of time. Perhaps, however, it is not quite time to commit to some of these “value” propositions. People are worried about the potential inflation that may come about due to the large government budget deficits and the possibility that the Federal Reserve will have to monetize a substantial amount of the debt created. But, there are many people who think that deflation is going to be more of an issue in the near term. Hence, it is perhaps a little premature to put funds into investments that will prosper from a future period of high inflation. This part of the portfolio should be kept safe, but also should be able to be accessed when the time is right to commit to the longer run fundamentals. Research, however, has shown that it is alright to be a little early on these types of investments because the possible returns on such a commitment to fundamentals are substantial enough that being a little early is not harmful.

It is also important that an investor should stay in the areas of the market that they know best. If your skills lend themselves to the technology sector of the stock market then stay there. If your skills are in the government bond market then stay there. If your skills are in the foreign exchange market then stay there. Again, discipline and focus are all important.

Uncertainty is going to remain with us for quite some time in financial markets and commodity markets. The behavioral economists have warned us that this is a dangerous time to act in just an impulsive or instinctive manner. So, if being methodical is not your “cup of tea” then beware for the statistics are not with you. Chasing every “green shoot” or market reaction is not going to produce happy results. Acting in a focused and disciplined way may be very difficult for us to achieve but we need to try. That is what humans have learned they must do in activities like investing in financial or commodity markets.

The Citigroup "Rally"

The performance of the stock market today, March 10, 2009, I believe, provides us with a clear indication of what is predominantly on the minds of investors. The major concern of investors is the value of the assets that are carried by companies on their books, and especially on the asset values on the balance sheets of financial institutions.

I say this because Citigroup has been the “poster child” of what most investors feel is wrong with the financial markets and the economy. The perception is that Citigroup is so weighed down by assets that are not performing and that must be written down that there is little or no hope for its survival outside of a full takeover by the United States government.

Focus has been so strongly focused on the “asset problem” that other institutions, like Bank of America and JP Morgan Chase & Co., have also been affected with concerns about the value of their assets. As a consequence, the stock price of these and other financial institutions have declined drastically due to the uncertainty as to whether or not they are solvent.

The stock market took off right from the opening bell this morning. The cause—a memo written by Vikram Pandit, the chief executive officer of Citigroup, to employees of his organization indicating that Citigroup had been profitable for the first two months of 2009 and was likely to turn a profit for the first quarter of the year. If this happens it will be a sharp turnaround in performance for the company, a move to the black after five consecutive quarterly losses.

There was no indication about any special write-offs or credit losses, but the memo gave hope to the idea that Citigroup, even after such write-downs, would post a profit for the first quarter.

The hope that was forthcoming, I believe, is the hope that Citigroup will now be operationally in the black going forward and that this kind of performance would give them the time and cushion to continue to work off bad assets and take more modest charge-offs against profits in the future.

The hope is certainly not that Citigroup is “out-of-the-woods.” That would be too much to hope for. To me, what is captured in the market response is that Citi may still have time and not be forced into some precipitous governmental takeover action.

Now, let me say that this was just one day and just one piece of action released by someone that needs, in the worst way, to give some sort of encouragement to his troops. Tomorrow is another day and there will be more information and more market maneuvering in the future. But, it was a day in which there was a possibility for hope—no matter have small that hope might be.

The problem had been that investors had perceived asset values declining with no bottom to be seen. And, there was no one or no event in sight that might put a stop to this decline.

This is why I believe that the financial markets have not been giving President Obama and his team “good grades” on their efforts to craft an economic policy and a bank rescue bill. The economic recovery plan was proposed and passed by Congress, yet there was no “bounce” in the market due to this program. So far, any bank rescue bill talked about or outlined has been deemed a dud.

It is this latter failure that the financial markets have been reacting to. To the financial markets the concern over asset values has dominated everything else. The recovery plan does not address this issue and so does not provide any confidence to investors over possible bankruptcies and takeovers related to institutions that are insolvent due to the bad assets on their books. Expenditures on infrastructure and education and health care and so on are one thing, but a stimulus package like the one that passed Congress cannot prevent a collapse of the financial system as the value of assets plummet and are recognized.

And, so the memo relating to the two-month performance of Citigroup hit the market and gave investors some encouragement that there might be some possibility that the problem related to asset values maybe…just maybe…could be worked out. And this attitude spread to other companies and other areas in the stock market.

We see that the stock of Bank of America Corp. rose 28 percent, the stock of JPMorgan Chase & Co. rose 23 percent, and the stocks of PNC Financial Services and Morgan Stanley increased by double digit numbers. Of especial interest is that the stock of GE rose by 20 percent reflecting the spillover of the positive attitude given to the banks was also given to GE and the concern over the fate of GE Capital.

Again, all of these companies have seen the price of their stocks decline in the past six months or so because of the concern over the value of their assets.

As mentioned, stocks rose from the opening bell, seemingly responding to the contents of the Pandit memo. But, the market responded to other news that they interpreted in a positive manner.

Fed Chairman Ben Bernanke gave a speech that reinforced the “good news” coming out of Citigroup. In this speech, Bernanke discussed the need for moving onto a new regulatory system. The part of his statement that market participants focused upon was Bernanke’s claim that the accounting rules that govern how companies value their assets needed to be changed. The Fed Chairman was careful to say that he did not believe that the mark-to-market accounting rules should be changed. Still he did talk about how asset values should be treated and investors reacted to this in a positive way. Again, the focus of the market was on asset values and little else.

There was one other bit of news that the financial markets reacted to in a positive way and that was the comment of Barney Frank about the “up-tick” rule. This statement, although important in itself, was only a side-show in the movement of the stock market today. Its just that when the good news is poring in, look out!

The important take away about the performance of the stock market today is that the major focus of the investment community is on the value of the assets on the balance sheets of banks and other organizations in this country. This message should be read loud and clear by the Obama administration. Spending plans are fine, but the recovery of the country depends very heavily on what is done about the value of the assets on the books of banks and other organizations and how losses in value are going to be worked off.

This is important too because of what is on coming in the future. It seems as if the credit problem is going to accelerate as the defaults rise on credit card debt, as interest rates need to be reset on Alt-A and option payment mortgages over the next 18 months or so, and the looming bust in the commercial real estate market. The asset value issue is not going to go away soon.

So, we got a rise in the stock market. We may get several more in the next week or so. I don’t believe anyone can predict the movement in the stock market over the coming six months. There are still too many uncertainties. And, even if the stock market were to rise over the next six months, my bet is that the asset valuation problem is still going to be with us. And, in all likelihood it will still be with us next year at this time.

Uncertain Asset Values and the Stock Market

“Value investors prefer to estimate the intrinsic value of a company by looking first at the assets and then at the current earnings power of a company.” This comes from the book “Value Investing: From Graham to Buffett and Beyond” by Greenwald, Kahn, Sonkin, and van Biema.

In value investing, the value of the assets is the first thing you should look at. Value, however, is uncertain and decisions about value are risky…that is, placing a bet on the value of an asset is a risky decision…and this throws us into a probabilistic world.

But uncertainty comes in different flavors. For example, in some situations we have a relatively good idea about what the underlying outcome distribution looks like. Games of chance like roulette or blackjack have uncertain outcomes but the probability distribution of possible outcomes is well known. On the other hand, the possible outcomes of a war are uncertain and we generally have very little knowledge of the probability distribution of possible outcomes. So at one end of the spectrum of uncertain situations we can say that our estimated probability is objectively determined, while at the other end we have to admit that our estimated probability distribution is entirely subjective.

The United States is at war right now…at war against an economic and financial crises. And, investors, as well as everyone else, have no idea what the probability distribution of possible outcomes looks like. We can’t even approximate such a distribution from historical statistics because there is insufficient information to produce any kind of a result that would be relevant in the current situation. The information that we are getting seems to be getting worse and worse.

This, to me, is why financial markets are performing as they are at the present time. No one can state with any certainty the values relating to the vast majority of assets in the United States.

Until people can gain some confidence that they know…even approximately…what is the value of assets relevant to them…they will not be willing to place substantial “bets” with much confidence. And, this will mean that financial markets will continue to meander lower.

One effort to get a handle on asset values is the “stress test” exercise of the Federal Government on large commercial banks. The effort is, of course, to see whether or not the asset values of these banks will hold up in a relatively severe economic downturn. The outcome of these stress tests will determine, to a large degree, the amount of financial help these institutions will get from the Treasury Department.

The problem is that the whole economy needs to face a stress test. It is not altogether clear that even the people running a large part of this economy have any idea about the value of their own assets. This is scary!

We have heard over and over again in the past year that one factor that has “caused” or at least “exacerbated” the current crisis is accounting rules such as the “mark to market” requirement faced by many institutions. I think that this is nonsense!

The problem, to me, is that there has been too little information forthcoming from the businesses and financial institutions in this country. I contend that the only reason the “mark to market” requirement might have caused organizations any trouble is that the managements of these companies believed that they would never be held to live up to this standard.

The “mark to market” requirement is meant to warn managements that their decisions with respect to asset choices will have consequences on their balance sheets and this will be revealed to the investment community in real time. Therefore, Mr. Management, if you want to invest in riskier assets or mis-match the maturities of your assets and liabilities in order to increase your return on equity, you will have to account for them “up front” if your decisions sour.

Knowing this to be the case, why would these managements go ahead and assume riskier positions unless they believed that the accounting rules would not be enforced?

Another bad argument to me is the one used by Long Term Capital Management in terms of the portfolio positions they took…”We can’t release information on our positions because of the fact that if we did our competitors would know what we are doing and copy us.”

Well, guess what? Their competitors knew what positions they were taking and copied them. And, the spreads Long Term Capital Management worked with got narrower and narrower…and so LTCM needed to use more and more leverage to get the returns they were shooting for…and trouble developed…and who knew about it? Not their banks…not their investors…not the regulators…no one but them. And, we ended up with another crisis.

And, this goes back even further. I am reading a book about Goldman Sachs. One situation stands out…the financial crisis created by the Penn Central bankruptcy in the early 1970s. The Penn Central hid information about its financial problems from Goldman Sachs, as well as others in the financial community, which resulted in a collapse of the commercial paper market leading to a Federal Reserve rescue and millions and millions of dollars in losses as well as an enormous amount of time in law suits and other regulatory assessments.

In doing bank turnarounds I found out very quickly in each bank I was involved in that the first thing an organization does when their decisions start going south is that they attempt to “cover up” results. One of the first things needed in any turnaround situation is to open up the books and let the fresh air in. It always seemed to me that greater openness and transparency of reporting results would have reduced the number of bank problems and bank failures that took place in this country.

Many argue that if people knew the trouble that banks had gotten themselves into there would be more “runs” on banks and the system would be less stable. This is an argument “after the fact” much as is the argument about “marking to market.” If the information were available earlier to the public and the investment community, there would be pressure on managements to respond quicker to bad decisions and resolve them before they got out-of-hand. Allowing the managements to delay action on these issues only exacerbates the problem, for it does not force the managements to solve them.

If there are to be any regulatory changes…and I am afraid that there will be way too many of them in our future…I would argue that the most important one would be related to the reporting requirements of all businesses in the United States. The records of American businesses…non-financial as well as financial…need to be more timely and more open and transparent to the world.

The investment community and the regulatory community should never be in a position where there is such uncertainty about asset values as there is at this time! We have the computer systems to accommodate a requirement to be more open and transparent…there is no reason why more information should not be forthcoming on a real time basis.

The stock market…as well as other financial markets…will continue to move lower as long as the uncertainty exists about asset values. A government “recovery program,” a plan to ease the burden of foreclosures, and even a bank bailout plan, will not stimulate bank lending and move the economy out of recession until we get a handle on asset values…throughout the whole economy. Valuing assets will take time…and even more time will be required to work out the associated solvency issues. But, even now, greater openness and transparency would help speed this process along. And, maybe give investors enough confidence to start buying again

The State of the Bailout

Treasury Secretary Paulson gave a press conference yesterday and indicated that things had changed…that the focus of the bailout effort would not be on the purchase of ‘toxic assets’ but would be aimed to assist the capital needs of financial institutions and consumer finance. This ‘shift’ in focus has been duly noted by the press.

Is the ‘bailout’ program having any success?

To answer this question, I am roughly in the same spot of someone I heard being interviewed on Marketplace on NPR radio: the ‘expert’ was asked the following question “Has the efforts to add liquidity to financial markets and financial institutions shown any results to date?” His reply: “I think things are better than they would have been if the efforts had not been made.”

Does that give you a lot of confidence?

I just don’t think that at this time anyone can say more. We are in the middle of a situation that no one present has ever been through. Fed Chairman Ben Bernanke, an expert on the Great Depression, has seen to it that financial markets and financial institutions have been flooded with liquidity. From the banking week ending September 10, 2008, Reserve Bank Credit has risen from about $890 billion to $2.1 trillion in the banking week ending November 5, 2008. This is roughly a 210% increase in a matter of 8 weeks. (Dare I remind you that it took 94 years for the total of Reserve Bank Credit to reach just $890 billion and only eight weeks to add $1,167 billion more!)

The $700 billion bailout bill…is now turning into a provision of capital for financial institutions…a provision that the Treasury hopes will buy time for institutions to work out their bad asset problems. The unknown question here is whether or not $700 billion is enough or will Congress have to float more funds.

The underlying rationale for the provision of all this liquidity is that either (1) officials are going to be blamed for allowing another MAJOR economic bust to take place or (2) these officials are going to have a problem cleaning up for all the liquidity that they have supplied to the financial markets on such short notice. Success, in the eyes of the officials means that they will have to clean up all the liquidity once the financial markets begin working again. Failure…”is not an option.”

No one knows at this time what is going to happen…

The idea is to keep tossing more and more liquidity into the pot until financial institutions feel that enough is enough! No one has been here before! This is all new!

Your guess is as good as mine…

And then there is the need for fiscal stimulus. The Congress is going to consider a stimulus package which seems to be similar to the first stimulus package they passed earlier this year. It will be aimed at consumers and, although it may not be any more effective than the first package, it can be done quickly, and it will show that the Congress IS doing something AND any little stimulus to the economy will be appreciated.

But, a second stimulus bill is being talked up. This one would be more capital intensive and aim at real projects like projects to rebuild the United States infrastructure. The idea here is that consumers are not going to start spending much until their job security is enhanced and they are sure that they will hold onto their homes. Businesses are going to have to restructure their balance sheets and have some confidence that consumers are going to start spending again before they loosen their purse strings and begin to invest in capital projects again. We seem to be a long way from either of these so the argument goes that the Government needs to engage in some real “Keynesian” pump-priming. The problem with a Government expenditure program like this is that it takes time to prepare and then, once the bill is passed, it takes time for the projects to be implemented. So, help does not come quickly.

And, what about the stock markets? When are they going to come back? Well, we hear all the time that the price an investor is willing to pay for a stock is dependent upon future cash flows. Right now, market expectations concerning future cash flows are pretty depressed and uncertain. Investors must be able to sense a turnaround in future cash flows for them to develop any confidence to begin purchasing stocks. And, investors don’t really know the value of the assets on the books of a large number of companies. To me, a good argument can still be made for more asset charge offs, more bankruptcies, and more depressed forecasts of future cash flows. In my mind, we are not near the bottom here, particularly given the situation described above.

What about uncertainty?

There is lots of it. Much of the uncertainty pertains to the programs that will be coming out of the new administration and the leadership that is put into place by that administration. It is still a long way until January 20, 2009. The current administration has been reluctant to do anything in the past until it became absolutely necessary to do something about the financial markets and the economy. They still want to pass on as much of the decision making as possible to the newly elected administration. So, we are still in a limbo as far as the national leadership is concerned.

What about the international situation and international leadership?

Also an unknown. People are talking about a new Bretton Woods…the international financial structure set up after the second world war. First off, that conference had two years of preparation and negotiation before the meeting was held. There has basically been little or no preparation for the meetings to take place this weekend. Second, the first Bretton Woods conference had seasoned world leadership behind it. That is not the case at the current time. Third, there is almost no intellectual consensus concerning the cause of the current situation and what should be done about it. Fourth, the world is still going through a economic downturn with more countries declaring every week that they are now in a recession.

International coordination and cooperation are going to have to be vital components of the world economic and financial markets in the future but for right now, I don’t think that we can expect much concrete to be forthcoming from the world community.

So, in my view, we will continue to see a downward drift to stock markets with a substantial amount of volatility. What else is new?

For bond markets, United States government securities are going to continue to be the pick for risk-averse investors and spreads will continue to rise between the least risky debt and that considered to be more risky. I saw that the spread between Baa corporate bonds and Aaa corporate bonds exceeded 300 basis points last week. For even lesser credits the spread has been increasing at an almost exponential rate. If there is any indication that the credit crisis is NOT over, it can be picked up from the market place.

The only thing that seems to be positive news at this time is that the Bush plan to get the price of oil below $60 a barrel has been tremendously successful so far!

The Reign of Uncertainty

The most dominant factor operating in markets at this time, domestic and international, is uncertainty. Yes, the price of oil is down. The price of gold and other commodities is down. The dollar is stronger. And, question have been raised…like has the dollar reached a bottom in value and now will recover (“Historical Trends Suggest That the Buck Is Back”, http://online.wsj.com/article/SB121961240718867281.html?mod=todays_us_money_and_investing.) Is inflation going to drop as the economy weakens so that interest rates don’t need to be raised? And so on, and so on.

What I see in world markets these days is not a “trend” here or a “trend” there. What I see is uncertainty. I see volatility with no clear direction, one way or the other. And, the uncertainty that exists is not connected to events, but to fundamental issues.

Three international issues immediately come to mind. The first of these has to do with Russia, the more active role it now seems to be playing, and the response of the rest of the world to the new feeling of power being exerted by Russia. The United States has expended a lot of its good will over the past seven years or so and is, at present, in no position to lead others against this exertion of will.

The second has to do with the other BRIC countries and the role they are going to play in the world economy in the future. China, of course, coming off the successful execution of the Olympic Games, is gaining in confidence every day. India, although it has its problems, is going to play a major role in the world economy going forward. And, Brazil seems to be growing stronger every day. The United States has little or no influence over the direction these nations move since it forfeited it’s ability to work with them when they were, economically, just emerging countries.

And, of course, there is the uncertainty related to world energy sources and the role that the Middle East plays within these markets. Although the demand for oil seems to have dropped off in the United States due to Americans driving less, the overall demand for energy in the world continues to climb. And, there is always the uncertainty relating to supply…we just don’t know what might happen here in terms of leaders and in terms of cultures. Of course, the militant forces of terrorism play a role in how this issue works itself out.

This just represents a start. We can remain at the world level and talk about the unraveling of the global consensus on trade. (http://www.ft.com/cms/s/0/111b33e6-71ff-11dd-a44a-0000779fd18c.html) Current economic relationships have been built upon the efforts of many people and nations to build a more global economy. This consensus is showing signs of weakness now and is in danger of collapsing. A world with more restricted trade and greater emphasis upon nationalism would certainty have major economic and financial ramifications for the world at this time.

There are other factors causing uncertainty internationally, but let’s take this discussion into the national level and focus on the United States. First, there is great uncertainty concerning the health of the financial system. The number one concern at this time is what is going to happen to Fannie Mae and Freddie Mac. Is the Federal Government going to have to step in and do something about them and if so what is going to be the resultant structure of the companies and what is such a bailout going to cost the American people? But, there is still concern about the health of investment banks and how large the additional write offs are going to be. There is concern about the commercial banking industry, whether or not there will be more bank failures and whether or not there will be a failure of one or more “major” banks. The fact that the FDIC is pulling back former employees that worked in bank examination and bank closures and workouts to augment its current staff is a source of some concern. Furthermore, there is no good estimate of the amount of charge offs that financial institutions will face…first in terms of mortgages, then credit cards, then…

Then there is the housing industry. How much further down will it go and how long will it take before the industry bottoms out and construction really begins again?

What about unemployment? The unemployment rate hit 5.7% last month and the projection is for this number to go higher and higher. But, how much higher? It seems as if layoffs and firings are just beginning. Many industries are going through major restructurings and we don’t know, as yet, what the final effect will be in terms of the employment numbers. Companies are going into bankruptcy. Other companies are reducing the number of retail outlets they have retrenching for the growth at any cost efforts of the past. The auto companies are asking the government for major dollars to help them make adjustments to the changing nature of the industry. And, in this environment, would you be terribly aggressive in expanding output or hiring new employees?

Higher unemployment means higher payments for unemployment compensation. The government will almost certainly give the auto companies financial help. The government is promising relief to people facing foreclosure on their homes. The bailout of “Fannie” and “Freddie” could run up to $200 billion. And, what if commercial bank failures, let alone the possible failure of another investment banking firm, put pressure on the FDIC’s insurance fund requiring the government to set aside more funds, how would that add to the deficit? And, these potentials demands for government monies are just a few of the possibilities along with the worldwide problems that could cause the Federal deficit to become even larger. What price will the United States Government pay to finance all the debt that could be amassed in the near future to handle the multitude of potential crises that could unfold?

Then there is the leadership concern. The Bush Administration is history…yet, it still is in office for almost five months. There are still members of the administration trying to leave some positive legacy behind them. There have been several recent articles discussing the efforts of Condoleezza Rice and Henry Paulson to do something positive before they leave office. The “big one” for Paulson is, of course, the Fannie Mae/Freddie Mac bailout. Everyone else seems to have just disappeared into the woodwork.

And, there is the case of the presidential candidates. I won’t go into that again…you can read my thoughts written in my blog for August 18, 2008 (http://maseportfolio.blogspot.com/). All I will say right now is that I don’t believe that either of the two candidates have given us a clear idea of what we can expect from them in the economics or financial arena if they are elected President.

The world is a highly uncertain place today. Given the nature of many of the factors contributing to this uncertainty, I don’t see how the uncertainty can be resolved in the short run. Because of this uncertainty, the risk associated with any business or investment decision will be higher than it has been for quite some time. Over the past several months we have seen this risk being built into market relationships, especially into the interest rate spreads that exist on financial markets. However, we are also seeing changes in relative pricing in the “real” economy as businesses adjust for the changing assessment of risk that exists within these markets. These re-evaluations, obviously, are not very encouraging for the stock market.

The prognosis for the future, therefore, is for volatility. Markets are going to go up and markets are going to go down, but it is going to be very difficult to determine longer term trends in such markets. There is just too much noise.

What will get us out of this mess? The answer to this dilemma is time, information, and leadership. Nationally, as well as internationally, we don’t have a vision of where we need to go. There is still much “pain” to be felt in the United States. Someone is going to have to “own up” to this pain and provide a map for getting through it, helping those hurt where possible. Until we get some idea of what is going to be done…uncertainty will reign in financial and economic markets.