Lean and Mean and Miniscule: The Downsizing of America

The recent “surprise earnings” that have led to this recent market rally may have surprised most, but not all. Some of us knew that this round of earnings would be good because of several factors.                                                                                                                                               The first is the fact that the financials, which are responsible for starting this whole rally, made money by trading during a three month run-up while using a crap load of free capital given to them by you (taxpayers). This is a topic for another blog entry to be sure.
The second factor is Wall Street’s ability to get investors to believe in the significance of these “earnings estimates” instead of looking for real earnings growth. Instead of real, positive increases in earnings, all you have to do is to do better than the analysts expect you to…..even if you still do badly! And the worst part is that the people who are doing the estimating have a vested, financial interest in the company beating the estimates. Talk about a conflict of interest!
But the real factor that gets me is how most, if not all of the companies in the US increased their earnings per share (EPS), not their revenues! They did this by cutting back expenses including labor and ultimately increasing earnings by decreasing their size. I hear so many analysts talking about these companies getting “lean and mean” and how good it will be for the future of the company…..what a laugh! American companies are downsizing to generate better earnings results but they may potentially be damaging their ability to compete on the global level. Eventually, this will have to be bad. Currently, we can begin to see the error in this concept by looking at the US automotive industry and the US banking industry.
The demise and downsizing of GM and Chrysler and the weakening of Ford have allowed foreign car makers to gain significant chunks of market share not only in the US but globally as well. Plant closings and massive layoffs have shrunk our car makers. This is creating a competitive disadvantage for the US car makers. Meanwhile, the banks have had to sell off assets to meet capital requirements and pay down losses in the credit markets. US banks are nowhere to be seen in the ranks of the top ten banks in the world!  When it comes to competing in the global financial markets, size matters!
My father once told me that in basketball, a good big man will always beat a great little man. The saying goes that you can’t teach size. And size (asset base) matters a great deal in this game too….the game of global business. Bigger is often better when in competition. Economies of scale really pay benefits to the companies big enough to exploit that scale. By diminishing the size of our companies here in the US, we lose the advantage of economies of scale and thereby hurt our pricing ability which is already hampered by US law as compared with other countries.
Lean and mean is one thing…..miniscule is another. The US could wind up having trouble competing globally with the big boys in the future because we may no longer be a “big boy” ourselves!

Ron

Out With the Old, in With the New…

New Years has always been a time for all of us to reflect on the year that has passed and look forward with optimism to the year ahead. This single cliché can be applied to just about any situation. I had this in mind when I was approached by a gentleman who engaged me in a conversation about the different hosts and guests who comment about the market on TV.

After discussing the accuracy and thought process of several different guests and hosts including Jack Welsh, Warren Buffett, Jim Cramer, and the late, great Mark Haynes, I was asked about where the gentlemen would go wrong with their views about the market. I think the gentleman was trying to get me to critique each of the styles of the different personalities.

As I thought about this, I came up with what I believed was a bit of a common theme in terms of a criticism in the thought process of these personalities. As I pondered the way these different personalities viewed the stock market and the US economy, I realized that for the first time in the history of the market, experience was their weakness! Not lack of experience mind you, but, the fact that they have too much experience!

You see, most stock market gurus rely on what has happened in the past to predict the future. Obviously, market technicians (chart readers) have to rely on history as technical analysis relies on finding reoccurring, historic pricing patterns. But even the fundamental analysts rely on how the market reacted to economic data in the past to determine how it would react today. This is their undoing!

Today’s US markets are NOTHING like what they were 5 years ago! Thus, all of the experience gained from 40, 50 years in the market has become more or less outdated. What was true back then is no longer true. As a matter of fact, reliance strongly on what happened many years ago to predict what might happen today could lead you in the wrong direction. It has occurred quite often to these and many other “experienced” market veterans. Today, their past often works against them and their experience may betray them!

The reason behind this is the fact that we have entered a phase of unprecedented globalization. More and more countries’ economies are going through industrialization faster than ever before. These new or emerging economies are maturing much faster than those that preceded them due to the influence of those already mature economies looking for new, additional opportunities. The different economies of the world are becoming more and more intertwined and dependent on each other.

Although a new development in the course of history, this intertwined effect is not an aberration but the new normal. It is uncharted waters and is producing effects on the US market that are new and unpredictable. Thus, the experience of veteran market professionals is not as reliable as it once was. A new experience is going to have to be gained over time and may be a painful adjustment for some old veterans.

As these thoughts passed through my head, another gentlemen asked me, in one sentence, to sum up what I thought would be the best advice I could give to an investor ready to get 2012 rolling. Out with the old and in with the new was my advice. Get rid of those old thoughts and experiences acquired through years of trudging through the US markets and adjust to the new. A new dawn awaits the US markets and the other global markets as well. Be prepared to continually learn and draw insights from the new experiences. Out with some old ways and in with the new!

2012 promises to be a really new year!

Nobody Cares What You Think!

When I first stepped onto the trading floor in 1987, I found out lessons were learned in a couple of different ways. One way was expense. Seemed that some important lessons had to be learned the hard way…..at great cost! Gaining experience sometimes had an expensive price tag. Another way to learn lessons was to listen to the cliché’s of the old guys. Sayings like “don’t fight the tape” and “go with the flow” were the older guys’ way of teaching the younger traders a lesson. That lesson, regardless of the cliché used, is that the market is bigger than you and doesn’t give a rat’s rear end what you think it should or shouldn’t do. The bottom line of their lesson was that “the market is going to do what it wants to do and there is no one big enough to stop it.”  There may be some “slows” and some “blips” but in the end the market is going to do its thing.  Individual investors should heed that advice!

As an investor, you must follow the market’s lead regardless of what your opinion is about the movement. Your position must match the market movement. If the market is going up, you need to be long. If the market is going down, you need to be short. This is the only way to make money consistently in the stock market. However, your opinion does come into play, just not in terms of position selection. Your opinion comes in when we are talking about equity selection and especially your hedge. When in agreement with the movement of the market, your hedge should be looser and smaller. When you disagree with the movement of the market, your hedge should be tighter and larger.

Maybe we should create a new cliché “trade the market and hedge your opinion!”

Signs Evident of Impending Crash?

The fact that the market crashes from time to time is indisputable. And with the rapid growth of globalization, there is a very good argument that these crashes will increase in frequency and severity as we go forward. To this end, there is no doubt. The question is when will these crashes occur? Some might say that a crash will occur when there is exceedingly bad news. But, whose job is it to determine what level of bad the term exceedingly represents?

Truth be told, there are many different potential catalysts that can cause a crash. Right now, we have three or four of these catalysts out there. But in reviewing previous crashes, it is plain to see that the catalysts are very diverse in nature. However, diverse catalysts be damned, there are two factors that always seem to be present. The first is an over-optimistic exuberance where the market trades up on hopes and emotions as opposed to real numbers and realistic expectations.

The second is a lack of shorts in the market. I know it sounds funny and that you would think the reverse would be true. But, it is not. You see, the short side traders are almost exclusively professionals and institutions. As professional traders, they are very likely, if not almost certainly going to scale out of their short positions. Scaling out means that they will buy back their short positions in pieces at different levels as the market or specific stock trades down.

Normally, these levels are determined by technical analysis. Due to this process, the shorts actually stabilize the downward movement of the market by their purchasing on the way down at support levels. This helps prevent a crash. The participation of the shorts helps the market to trade down in more of a “stairway” looking charting movement as opposed to an “elevator shaft” downward movement that is a crash.

Today, both of these two factors are present in the market. Each of the past three rallies has been powered by an over abundance of optimism. In the current rally, the spark was word that both Germany and France have agreed that they need to sit down and work out a plan to help stabilize and secure capitalization of the European banks. The market rallies 1000 DOW points simply because two parties decide to talk? What if they can’t come to an agreement? What if the plan they hatch is not big enough? What if it simply doesn’t work? We are this excited about the fact they are going to talk? And we did not know this? This is news? Good enough to run the DOW 1000 points? Kind of optimistic aren’t we?

The rally prior to this one was powered by expectations that the Fed was going to possibly initiate QE3 which the Fed had already made clear that it was not going to do. Prior to the rally, the Fed even said that it was going to use a tactic called “The Twist.” Yet investors still bought up the market like crazy with the hopes that the Fed had been lying and was going to surprise us with QE3. The Fed did the “Twist” and not QE3 and the market sold off hard. Same type of thing happened the time before that too. There is just way too much optimism again…..and still!

The other note of concern is that each of the last three rallies has started with short squeezes chasing the shorts out of the market. This is evident with the speed of the rally and how quickly the volume dies out on it. This is very typical of a bull rally in a bear market. At some point in time, enough shorts are missing from the market and as we approach a support level, we break it aggressively because there is no one at the support to buy. As we approach the next support level we again see no buyers because no one is short. Next thing you know, we are falling off a cliff with supports being broken like a hot knife goes through melted butter! Then, it is on…..a crash!

Now, I am not necessarily predicting a coming crash. I am just saying that the two major factors that must be in place are in place right now! TREAD CAREFULLY!!!

Will it ever end?

I’ve been hearing Obama talking big about cleaning up Wall Street for a while now. So, I just had to laugh when I heard Maria Bartiromo talking about the upcoming earnings season that will be starting the first week or so of October. She basically said that once earnings season gets here, investors will stop focusing on the problems in Europe and focus on the US company earnings results.

That wasn’t the part that made me laugh however. What made me laugh is that the guy who was with her said that analysts were already starting to lower estimates across the board due to the current economic situation around the globe. Maria then emphasized the importance of these earnings in determining what is really happening out there. Seriously Maria, how the hell can we know what is really going on out there if the analysts are just going to move down the expectations making the results look better than they actually are.

Does anyone else out there besides me see and understand the irony here? I mean really, if we keep lowering the bar and accept lousy results that we call good because we lower the expectation down to the actual result then according to these ”pie in the skyers”  we have never been in a recession. We are always in the days of wine and roses!

When will this nonsense end? When are we going to allow companies that don’t do well to get punished for their lack of performance in the same manner that we praise and reward companies that actually do well? When will we stop constantly lowering expectations to make companies who are not good look good?

It is not just Wall Street and the analysts who are guilty of this conspiracy, it is the media too! The media always plays up when companies beat estimates even when the estimates are cut substantially and more! The media never reports that the company beat estimates but the estimates had been cut in half in the past two weeks, do they? It would make a big difference to me….how about you?

When will the powers that be understand that this earnings estimate game that Wall Street plays so well and that the media is an unwitting accomplice to is dangerous and misleading to investors? Maybe, they all actually want it that way. If that is true, then it will never end!

Nostra-RON-mus

Currently, the US leadership and dominance of the global economy is being threatened. The US is losing its place at the head of the table mainly due to the latest recession and its subsequent anemic recovery that has lasted for close to four years now. During that time, many countries have been growing at an incredible rate….namely China and India. Those countries are starting to enter an “industrial revolution” phase which could eventually catapult their economies above ours. I am not saying that this will definitely happen nor would it be able to happen soon. However, if it does happen, the US will need to respond swiftly and smartly (probably putting it beyond the ability of our current government leaders) to regain our edge, our place at the head of the table.

The question is how. We are miserably in debt. We have lost our manufacturing advantage. We have some resources but not enough to be selling out to others in size. Enter Nostra-RON-mus! When I look into the future, I do see a way for the US to reclaim its rightful throne. There is an intersection between something that I believe will turn out to be the most valued thing on the planet and the US’s sole ability to totally dominate on a global scale……FOOD!

Everyone has been trying to figure out what the next big investment vehicle will be. Some say oil and they say oil will be the next gold. Some people say it will be gold itself as it will officially become the global currency. But, you can’t eat a gold bar nor can you drink a glass of oil. With growing populations worldwide, described by some experts as a population explosion, estimates show that we are going to have to produce more food in the next 80 years than we have in the last 40,000 years.

This is where the US can turn the tide of global power. Of the major industrialized countries, the US has the most consistent geographical growing season. Further, if the US really wanted to, it has the room and the technology to grow crops and raise animals in large proportions. And don’t forget, the US has access to the largest fresh water supply in the world….the Great Lakes! If the US put all of these advantages to work and pushed serious resources into this area, the US would be far and away the biggest producer and supplier of food and water in the world at a time when there will be gigantic demand and anemic supply!

When you are starving, you’ll do anything to get food. The Middle East wants a dozen eggs, no problem…only costs 12 barrels of oil. Russia wants some wheat, no problem….only costs 10 gold bars. Get the picture?

The Bernanke Definition of Insanity

Last week our fearless (not to mention mindless) Federal Reserve Bank Chairman Ben Bernanke showed us two things. The first one was that the old saying “if at first you don’t succeed, try, try again” is alive and well in the Federal Reserve’s fantasy land view of the US economy. The second was his confirmation of the definition of insanity….doing the same thing over and over and expecting a different outcome.

 At the outset of the stock market crash a few years ago, the one caused by the sub-prime debt crisis, the economy was in a death spiral and the Fed needed to act. Bernanke’s first move was to take interest rates down to zero (actually 0.25%). The second was to initiate a $600 billion dollar quantitative easing program (QE1). After two years of rates at historic lows, plus at least an additional $600 billion in quantitative easing (QE2), today’s economy is just as bad as it was then. In addition, we now run a gigantic risk of runaway inflation. When the economy finally does turn around and heats back up only the deftest, smoothest hand will be able to raise rates fast enough to keep inflation under control, but, not so fast that the timing of the hikes puts a premature and potentially dangerous halt to a real recovery.

 As bad as this situation sounds, it could get worse. Bernanke’s promise to keep rates at the record low levels for the next two years just got compounded by a statement by Atlanta Fed President Lockhart. He stated(or perhaps warned) that, “If additional actions are required, I can assure you the Federal Reserve is not out of bullets. Expansion of the balance sheet or changes in the composition of the Fed’s asset portfolio are available, in my view.” Is he foretelling QE3??? (QE3 refers to speculation that the Fed may eventually undertake a third round of asset purchases known as “quantitative easing” to boost the economy.) He indicated that there was no worry or concern about overloading the Fed’s balance sheet. He stated that the Fed has not fired its last bullet as many believe. I guess the printing presses still have plenty of ink!

 It seems we have been down this road before. We tried the same procedures before with QE1 and QE2 and they did not work in fixing the economy in the short term and actually seriously complicated and jeopardized the economy in the long term. Now, here we are about to try more of the same thing that didn’t work twice before. I’m sorry…….what was the definition of insanity again, Ben?

Selling us Short

With all the trouble in the overseas markets right now, one of the ideas being bounced around is the idea of banning short selling. When we here in the US decided to try the same thing, we found out two facts about it that we did not know prior. First, individual investors loved the idea.  They thought it would be the answer to the problem of a declining market. The second thing we learned, a vastly more important lesson, is that banning short selling does not work! In addition, it does a disservice to individual investors like you and me by putting us at further risk!

Let me explain mechanically why banning short selling does not work. It does not prevent market sell-offs or crashes! You see, your average, everyday investor is not the one selling stocks short. It is the professional traders and the big institutions. These two groups are the ones who are responsible for almost all the short selling in the market. Now these two groups of professionals know the business pretty well and have found a way around the short selling rule. Instead of selling the stock short, they will just buy puts!

They will buy puts from the market makers on the floor of the exchange. See, what they know that you don’t is that the market makers have a short stock exemption. That means they are allowed to hold short stock positions and they are allowed to short stock on a downtick. This is because they have a fiduciary responsibility to provide liquidity. For instance, say you wanted to buy some puts and the market makers sell them to you. You would become long the puts and the market makers would become short the puts. Now, the market makers would have unlimited downside exposure. The market makers need to hedge their position and often they have to do it by using the stock.

In order to facilitate the customer order, the market makers have to be able to sell the stock short! If they do not have the ability to sell the stock short, the market makers would not be able to provide the type of liquidity that the US markets call for and need. Knowing this, the SEC provided the market makers with an exemption so that they can always provide the type of liquidity that separates the US markets from all the others.

What I am trying to point out is that the institutions have figured out how to side step this rule. Stock is still getting shorted, it is just not the institutions doing it……it is the market makers doing it for the institutions. All the rule has done is to make shorting the stock a two step process instead of one step. Either way, the stock is still getting shorted….the rule has NO effect! But, there is collateral damage. With the institutions and professional traders rushing out to buy puts, the price of puts will go up via an increase in volatility. This makes it much more expensive and a lot more difficult for individual investors like us to purchase protection in worrisome times. In essence, the only effect of the short selling ban is the increase in the price of our insurance. 

 

Today’s Bull (shit) Rally

 The market was schizophrenic to say the least today. Last night the pre-market futures indicated an opening down about 200 DOW points. An early morning jolt spun the pre-market futures around and the stock market opened up 200 DOW points and held that through the day until about 2pm. At that time, the Fed came out with their statement. The first part of the statement was extremely negative.  Bernanke stated that the recovery was now a contraction and that it seemed as if recession was headed our way. The market responded swiftly and violently taking an up 200 day and making it a down 200 day in a matter of minutes. It just so happens that this low of the sell-off coincided with the low from the late night pre-market futures.

However, Bernanke was not through speaking. Although not confirming the rumors (hopes) that QE3 was around the corner, he did make the statement that the Fed would keep US Rates where they are- between 0 and .25 percent. The market took off on this news that rates would remain at record lows for the next 2 years.   The Dow recaptured the 200  lost  points and preceded to run up another 400 points, most of it in the last hour of the day.

This bull (shit) rally was most certainly an orchestrated event. Once Bernanke gave us the bad economic news, the market traded down hard and broke down through the all-important support level of DOW 10,800 which was pretty much the prior night’s close. With the breakdown  underway, the shorts hop in and push the market down hard due to the indicated technical breakdown of the DOW 10,800 support level. Now, with the shorts carrying the day, the DOW traded down to 10,600 which, as I mentioned, coincides with the low from the prior night’s pre-market futures. At that moment, the Fed makes the statement that they will keep interest rates right here where they are at record lows.

 The Fed did not say they would initiate QE3, which was the rumor that made the market bounce this morning in the first place. That is the moment when the PPT stepped in and started buying the hell out of the market. This started a massive short squeeze as the market traded back up above the all important DOW 10,800 support creating a “false breakdown” and the short squeeze really takes hold with the PPT buying the whole way up. Luck has it that the short squeeze aided rally was even able to get back up above a lighter but still there DOW 11,200 resistance.

 This coordinated effort, led by the Bernanke statement, basically eliminated the Treasury market as a wanted and even viable investment alternative for the next two years. The problem is that this move, although short term effective, is the same stupid crap that Bernanke pulled in 2008 to try to boost the stock market and build consumer confidence to help boost the economy. It did not work before and I doubt it will work again as more investors are “onto” the Fed and Bernanke’s games. And the stakes are higher now for the Fed and Bernanke and ultimately the US…….more to come on that!

 

Double Dip Anyone?

 July started out with a bang as the DOW had a big first day closing up roughly 180 points to 12,582.77. It seemed poised for a great month as earnings season was going to start around the middle of the month. Earnings season is the darling season of Wall Street and the time when the Street can really move the market up by setting earnings expectations lower than they should be so that companies can pretty consistently beat those expectations.  That, in turn, drives stock prices higher.

However, July’s earnings season started differently due to the negative overseas news that came out in the first two weeks. The Greek debt situation reemerged and a second bailout was necessary. That story quieted quickly since it appeared the Euro powers were united in saving Greece and that a plan to do so was well on the way to being put in place.  But, only a couple days later the market was spooked again when the details of the deal came out. The plan to save Greece seemed to involve Greece actually defaulting…albeit a sort of structured, soft default. The market did not take that well.

In addition, the news on the growth rate of China and India played an even more influential role in the market’s direction. It appears that the steps taken by China and India to slow down their growth rates is starting to show signs of really working.  Their noticeable slowdown will definitely have an effect on the speed of the global recovery. It would also affect the US markets at some point as I stated several months ago when China started getting serious about raising its rates and restricting its banks from making loans. My contention here is that many of the big US companies who have been doing so well and have helped rally the market over the last couple of years, have been really expanding their earnings through explosive increases in sales in China and India. If China and India slow down then the sales pipeline that our US companies have counted on will be choked off and their earnings will suffer.

An example of that was seen with CAT.  Last month Caterpillar reported lower earnings due to a slowdown in China and India. That news sent CAT stock tumbling and the rest of the market went down with it. That news and the implications of it are probably weighing on the market even more heavily than the biggest story of the month….the US debt ceiling.

As I write this, the August 2 deadline date for raising the debt ceiling is fast approaching and we will have a definitive answer on whether or not we default. The potential repercussions are far reaching but, regardless of the outcome, the US debt rating of AAA may be downgraded to AA anyway. Among other things, this action would send loan rates up on every single type of loan in the market today. Mortgages will become more expensive, business loans, home equity loans, all would become more expensive. The rates that local, state, and federal governments pay to borrow money would all increase. And as of this moment, with no agreement on the debt ceiling, with the contentious speculations about it and with the potential downgrading of the US debt rating the market is back down over 500 points to its level at the beginning of the month.

So, July was a sideways month that started off well with a rally in expectation of earnings season and was then derailed by economic news from overseas and our own debt situation.  What will August bring?  Hopefully, political action here will give confidence to stave off a double dip!!!!!

Situation in Greece getting very slippery

Last week the market rallied back over 12,000 as investors got very excited about the plans for the bailout of Greece. The US dollar, the safe harbor of global currencies, was strangely up on this news. The question was “why?” If Greece was going to get bailed out, one would think that it would take the pressure off Greece and the rest of the Euro Zone lending confidence in the region and strengthening those currencies but weakening the dollar as investors would reinvest in Europe and step out of the dollar.

Well, that did not happen. The US Dollar was up on that day and now we know why. Seems that where Germany and the rest of the Euro Zone players had come up with a plan of action……which was greeted by a nice rally on Wall Street……that very quietly, and not immediately, we learned  the strings that were attached. Seems we found out a few days later…..over the weekend…..that no money would be paid to Greece until Greece put in a very strict austerity plan that most viewing the situation feel will probably not go through.

There are already protests and strikes going on in Greece spawned by the first round of austerity plans which are nowhere near as tough as the ones that are coming. So, the positive outlook brought by the news of a deal is not so positive now that we know what Greece has to do to get the deal executed. This brings about the higher percentage chance that Greece will default. With Portugal, Italy, Spain, and Ireland under watch and warnings from Moody’s, a default in Greece would not only cause damage in Greece but could push these other, tenuous economies over the edge of what is a very slippery slope.