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Friday, November 14, 2008

Hitting the Bottom

This is an ongoing argument in our household. One of us believes that bad news in the market place leads to an ever growing spiral, loss, and bankruptcy. The other, namely RL, that the market cannot really start to rebound until all the bad news is out, and the nay sayers have had their fill.

I get the argument she makes, and my pay check depends on large part the extent to which we can prove that to be the case. Let me flesh that out a bit. If Jamie Dimon, Paulsen, or even Oprah Winfrey, or any well-known public figure, tomorrow declares that the price of eggs will go down. Then the stock price of eggs will go down tomorrow, not because of internal market forces, the cost of production, shipping, etc. Merely because the bad news hit the market and people said, I'm getting out now. For this reason, she says, people who are in such a powerful position should prudently, shut the hell up.

I disagree. On a couple of different levels. First, the matter of market disclosure is a sticky one for us. It's one thing for a totally random person like Oprah to shut the hell up, but a completely different thing for say, the CFO of Bear Stearns to shut the hell up. That is, in fact, against the law. This is why Ralph Cioffi, and Mathew Tannin of Bear Stearns fame will face a superceding indictment in January. What I've learned from my accounting classes, is that it is perfectly justifiable for internal management to conceal some things from their investors. Within reason. The problem comes when people are concealing too much. Which has clearly been happening for some time. You will see some changes in accounting next year. In fact, I think the next two years will see some changes in mark-to-market accounting.

Here's another thing: in securities law, when we talk about loss, we talk about inflation. Not to be confused with endless printing of money, or the fed lowering interest rates (again and again and again.) An analyst will take the average price index and compare that line against the inflated stock. The difference, therefore is the inflation. Look at the chart to the right. The top line is JDSU stock price, the bottom line is what the market was doing at the time. The difference is the stock inflation. Now clearly, this is but one stock. What happens when the market itself is inflated? Well that's what we're seeing now. Paul Krugman had a good op-ed on this recently. But this is the crux of why I think we need to hear the badnews all of it.

In a bull market, if a firm says they have bad news, (they're not going to hit their quarterly marks for instance,)the marketprice of the stock drops. In a bull market, that is considered really bad news. This prompts firms to lie about losses. And they do, routinely. Because everyone else is, and they know that if they're the only one being honest, the market will reward them by taking away their financing. This happened most recently in the tech industry in the 90s. Almost every single major tech firm's stock was wildly inflated, and they all were having similar difficulties. Too much stock, obsolesence costs, flat-lining sales.

But what I'm saying, is that in a bear market, bad news is actually good. After 6 or 7 years of rampant inflation (and some analysts argue as much as 10 years) the more bad news we get, the more the marketplace actually begins to represent reality. Then, we can start building profits again. To the right you see the inflation in the stock market--the housing bubble. This gives you an idea of how far we have to go before we hit the prices that we ought to be at. Still, things could get worse. Here's where I'm coming from: most of the blogs, and news that I've read for the 8 years have pointed irrevocably toward this moment. The BLS publishes this information every quarter for christsake. Everything's rosy, but the middle and lower class have less and less in their pockets. Well now they know. And that's a good thing. News will continue to be morose and desperate for at least two more quarters to come. But that doesn't mean that the news makers are responsible for the slagging market. These factors have been building for years, and the spinning, pontificating, talking heads have finally begun to notice. Bonddad has been talking about this stuff for the last two years, so a certain amount of realization has to occur. And the worse people's expectations become, the more tension can be released in the market.
Best buy made this prediction yesterday. And that too was good news. For the last decade creditcard use has quadroupled. What did you expect? If wages have gotten lower with inflation, who was doing all the buying? We were, on our credit cards. Well, people have finally wised up, they see debt as a problem now and they're getting help. So of course sales will be down. We want predictions to be honest and realistic. This was the market check that people like me have been expecting for years. Of course, I never dreamed that investment banking industry would be completely destroyed, but, frankly I won't miss them. They brought this on themselves, and they paid the consequences. And reaped the rewards. So if bear markets are like the brush fire that levels the forest, then we can look forward to a nice long period of clean growth coming.

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