Friday, November 28, 2008

Is the cat alive or not?

This isn't some treatise on Schrödinger's cat. Go ahead and look in the box if you must; I'll wait. Satisfied?

No, I refer to the Wall Street expression regarding a surge in stock indices and prices after a prolonged slump. If stocks fall, fall, and fall some more before suddenly reversing direction, there are two ways the trend can go. They can continue to rise, meaning the big sell-off is over, or they can resume their plunge after the short rally. If the latter occurs, it's called a "dead cat bounce," since the market has bounced exactly as many times as a dead cat will bounce if dropped.

The current do-nothing Congress has continued to resist eliminating the insane "mark-to-market" rules for financial institutions, thus causing bank after bank to mark its assets at a perilously low level. Then, the bank must sell assets or issue more stock, in a depressed market, to temporarily stave off regulatory wrath. However, a bank that keeps issuing stock and selling depressed assets sees the value of those assets continue to fall, and so the cycle repeats a few months--or even weeks--later. This short-sighted rule has turned paper losses into actual losses counted in the billions of dollars. End mark-to-market now, Congress. We can wait until next year to rip up Sarbanes-Oxley, called by some wags the "London Stock Exchange Stimulus Package," since many corporations have decided to skip New York and incorporate in London, where the atmosphere is more civil.

Anyway, the fire-sales coming from financial institutions and hedge funds have worked to seriously depress equity prices and, due to looming financial losses, bond prices as well. Is it nearly over? Well, yes and no. The rapid forced sales of equities may be nearing an end, but what about the fundamentals of the companies represented by those equities? Many forecasters expect 2009 to be a lean year indeed for corporate earnings, so while the prices of stocks have fallen, their P/E ratios--looking forward to next year's earnings--haven't improved all that much. Stocks may be cheap now, but they can get cheaper, and spend quite some time in this wilderness before they approach 2007's lofty levels.

Add to this the federal government's continuing drive to increase the deficit over the next 24 months by well over a trillion dollars beyond previous forecasts, and we don't see any realistic hope of tax cuts from the next Congress. Too, the massive cash infusion will continue to cheapen the Dollar--gold at its current eight hundred and something dollar price may look cheap by 2010, and if we're still enjoying sub-$100 oil it will be mainly due to a global economic slowdown.

Disappointing earnings, a shrinking Dollar caused by increasing inflation, and always the wrong answers from Congress--look for calls for still more onerous regulations on the American businesses that did nothing wrong here--point to a period of stagnant stock market prices. It may indeed be a good time to buy, now and over the next year or two, but don't expect big returns before 2011 or later. That said, waiting for a definite bottom to buy may result in missing the large, steep upsurge in stock prices that will eventually occur. So I'll buy shares of strong, profitable companies whose stock is depressed beyond reason, but keep plenty of cash free, since I can't count on selling those shares for a significant profit for a while. Think it over.

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