Financial Market Commentary

Posted by Rob Weigand. The increasingly negative mood on Wall Street provides us with a good learning laboratory. As I’ve written previously, periods of declining stock prices are great times to study investments because they focus our attention. When prices are rising and we’re all getting wealthier, we tend to ask fewer questions. We’re not compelled to figure out how things work as much as we are when our portfolios are declining in value on a near daily basis.

As Pimco’s Bill Gross recently put it: “We have for so long now been willing to be entertained rather than informed, that we more or less accept majority opinion, perpetually shaped by a ratings-obsessed media, at face value” (from the June 2008 Pimco Market Commentary).

This posting will explain why the current market mood turned so negative so quickly. The subtle conspiracy of good news that the financial media has been feeding us has finally exhausted itself. My second choice title for this posting was Harvest of the Hypesters.  The hypesters I’m referring to include all those anonymous geniuses and their risk management models who developed the “structured products” that have gummed up the global financial system, but also some “brand name” hypesters that are worth a quick mention.

Number one on this list has to be Ed Yardeni, who has been selling clients on his “Great Global Boom” story since 2003. Ed used to give academics a free subscription to his website and daily emails, which I used to think was quite generous of him. It was helpful to see how he constructed his overall strategy, and I appreciate the years of insightful reading he provided. I became suspicious, however, when he abruptly stopped the subscription. I am now of the opinion that when Ed was broadcasting the Great Global Boom story, he wanted to feed it through as many channels as possible. But when he was about to change his tune to the Great Doom and Gloom story, he didn’t want his about-face visible to the world-at-large.

Another hypester that deserves a quick mention is Jim Cramer, the clown prince of cable TV, who has done more harm to individual investors than anyone in history. The damage inflicted by Cramer stems not so much from his poor stock picking ability, which has been documented by academic research, but more from the “shoot-from-the-hip” approach to “investing” (actually trading) he promotes. Cramer’s advice results in clients trading far too often and generating fees and commissions that make the brokerages wealthier and the clients poorer. Having come of age in investing watching the thoughtful Louis Ruykeyser program for years, I am deeply saddened to see the millions of people who watch Cramer’s idiotic histrionics, and so enthusiastically. Like Ann Coulter, Cramer gets rich simply by acting outrageous at our collective expense.

Abby Joseph Cohen is another Hypester-Hall-Of-Famer who was quietly demoted by Goldman Sachs in late 2007 when her perennially cheery market forecasts outlived their usefulness. For years Ms. Cohen was trotted out in front of the cameras to offer her matronly brand of comfort whenever markets got preoccupied with a bit of bad news. I miss watching her eyes comically dart back and forth as she struggled against the teleprompter while reading the propagnda du jour. Ms. Cohen’s professional persona was a fictional character, created to feed the positive propaganda machine — she was renowned for endearing folksly habits like thiftily riding the bus from Queens to Manhattan every day.  In the Grand Theater of the Financial Media Ms. Cohen played the role of the scholarly librarian who “shushed” our fears and comforted us with the same bedtime story every day — markets can only go higher, and if we stay fully invested in equities we will all live happily ever after.

How about a quick mention for Forbes’ Ken Fisher, who in December 2007 published a column informing readers that “we are entering an era of above-average returns.” Well, they say timing is everything. Of course, Fisher has issued this pronouncement regularly for the past decade — despite the fact that it’s been a period of below-average returns, something well-known to every portfolio manager from Boston to Bangla Desh.

As I wind down this rant, let’s not overlook Dylan “The Brawler” Brautigan (“I’ll thrrrrash any man who says a word agin’ these marrrrkets!”) and his merry band of wild-eyed traders on CNBC’s “Fast Money.” (Don’t you just love the guy on the show with the ninja ponytail who never blinks? You know, the samurai options trader.) Or how about Maria-the-Diva Bartiromo, who saves her sultry “come hither” glances only for the most bullish guests. Whoops — almost forgot Larry Kudlow, who’s been touting the “Goldilocks” economy (everything is just right) for months now. Yeah, Larry, everything is just right. I know a few million subprime mortgage holders who would love to throw a bowl of scalding porridge right in your face.

Conclusion: These people are not journalists. They are actors on the stage that’s become our national financial media.

Now, before you criticize me for being biased and not applauding the prescient calls of some of the doom-and-gloom market forecasters, allow me to point out — there are almost none to applaud. You can’t survive in the investments business if you broadcast a cautionary tale in public. You have to save that for the real advice you offer privately to your best clients. Viewers don’t watch as much CNBC and Bloomberg TV when markets are falling and the outlook is gloomy. And advertisers aren’t interested in buying ads on TV stations that focus on bad news — even when bad news is reality.

To better understand how this stream of positively-biased information has been affecting markets, let’s get technical for a moment. Picture a regression equation with stock market returns (on the left-hand side) explained by a set of factors on the right-hand side such as economic growth, inflation and interest rates, consumer spending, the trade deficit, the relative value of currencies, etc. And remember that each of the explanatory factors has a regression coefficient attached to it — the coefficient measures how sensitive stock returns are to each factor. Now here’s the key point — market participants decide, collectively, how much to weight each factor. Even when the news is bad, they can completely ignore it — the market sometimes assigns a negative weight to bad news (think about the way stocks surged in the Fall of 2007 despite horrible news, and rose again in the Spring of 2008 under similar circumstances).

So what’s going on now? Why are stock prices falling every day? People have stopped ignoring reality. There is simply not a shred of good news out there to divert our attention from what’s been going on. Let’s go down the list of what’s on their mind. It’s not a pretty picture.

Remember how we were supposed to be transitioning to a “knowledge economy?” Well, it seems that all the brainpower that’s been concentrated into money management has resulted in the current financial crisis — the worst since the Great Depression. Is it too outrageous to propose that it’s time to consider re-assigning these people to jobs where they can do far less harm? It might be easier to just pay them to stay home for the rest of their lives. All these astrophysicists and aeronautical engineers running hedge funds and investment banks have used their great mathematical sophistication to tie the world’s financial system into an enormously complicated knot. Our rationale for locking people up in Guantanamo was that it would prevent future terrorist attacks. Well, these people have committed terrorist acts on the global financial system and the wealth and prosperity of the United States. Sequestering them on a desert island might create value in the aggregate.

So we’re the world leader in banking and investing and this is where it got us. Great. Well, at least we can fall back on making stuff, right? Whoops, not so fast. At the market close on June 26, CNBC reported that General Motors’ stock is now at a 50-year low. There is a non-zero probability GM will go bankrupt. Detroit has been downsizing jobs for years, a trend that may be radically accelerating in the near future.

When he was circulating his newsletter, Yardeni once quipped, “I’m not giving up on U.S. consumers — every time I’m tempted to turn negative, they bail me out.” The U.S. consumer is in sad shape and unlikely to bail anyone out for quite a while. Households have too much debt, not enough retirement savings, and many have negative equity in their homes, which continue to fall in value. Good thing the tax breaks of the last eight years mainly benefitted the ultra-wealthy.

Well, the only thing that could make all of the above worse would be inflation. And guess what? We’ve got an inflation problem, and world central banks are not coordinated in their approach to fighting it. The European Central Bank is raising rates while the U.S. Fed is sitting tight. News of this drove the U.S. dollar sharply lower, after it had rallied a little in recent weeks. And a weaker dollar just makes the inflation problem worse. Laughably (if you like having jokes played on you), one of the arguments as to why the Fed can wait to act is that we don’t have a “wage-price” spiral as we did in the 1970s. That means that salaries are not keeping up with inflation. Well, that’s great news, isn’t it? The U.S. consumer is not only in a tight spot, but is so worried about being laid off from work that he/she can’t even ask for a fair pay increase any more.

And that, gentle reader, is why stock prices are falling every day.

You can write to Rob Weigand at profweigand@yahoo.com or find him on the Web at Rob Weigand’s Home Page.