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TheGarcipian (36.00)

Road Signs: You Are Here (Part One)

Recs

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January 25, 2009 – Comments (0)

If the “road to Hell is paved with good intentions,” then I’ve certainly missed quite a few sign posts on the road to Financial Armageddon. And much as this road sign depicts,

Retrospective Road Sign

it’s all so much clearer in retrospect… In moving forward this year, I hope to improve my foresight over the coming months, and being very selective in my real-world stock picks. I’ve also been reading about how some people are tired of all the “doom-n-gloom” rhetoric, so I decided to spice it up with a little fact-finding mission of my own. (Warning for the weak of heart: It ain’t pretty; go back to your Bingo game and lottery investing). Here are the road signs as I see them now:

No B.S. sign   Calling Out the BS via the BIS

Let’s start at the beginning, or at least where I think the problem started. As GoNuke noted in a response to this TMF article: “Infinite leverage is just stupid. The Bank of International Settlements (BIS) is a transnational institution created by a treaty signed by 55 countries including the US. The BIS stipulates capital adequacy ratios precisely to prevent banks from becoming over-leveraged. They are supposed to have equity equal to 8% of the risk weighted average of their loan portfolio. This is supposed to limit bank leverage to 12.5 times equity.”

At the height of the most recent bubble, banks and investment houses were leveraged up to 30x (and some 40x!) their equity – insane, greed-laden figures, for sure. They have nowhere to dish that carcinogenic paper now because nobody wants it, most demanding their money back. This was one of the consequences of market de-regulation at the hands of the banking & financial lobbies, congressmen tripping over themselves to help out Big Business (and line their own pockets) at the expense of prudence, Small Business, Labor, and most of the American people. Shame on you all for passing the GLBA in late 1999, the source of most of our financial troubles today. I lay that squarely at your feet. Sure, the loose money policies of the Greenspan years didn’t help, but you knew that before passing the GLBA. Our lending standards back then were adequate, but when you pull the brakes out of the locomotive heading downhill, how can you cry that it wasn’t your fault for the train wreck? I don’t buy any of the bullcrud that a Republican Administration and Republican-led Congress inherited a downsizing economy from Clinton. Sorry, that’s going to hurt some feelings, but I’m just calling like I see it, cutting through the BS. If they really believed that, Bush & Cronies would not have shelled out those tax rebates in mid-2000 knowing full well that they’d deplete a $237B surplus left by Clinton and have nothing to save for a rainy day. No, Congress and Mr. Ex-President, the blame lies squarely on your shoulders. Certainly too much regulation can kill any industry, but too little of it generates unrealistic & unchecked greed. Too little of it fosters conditions in which many suffer at the hands of a few. We should all understand that by now. Regulation is like insurance in three ways: (a) it is a necessary evil; (b) use it moderately (not too little, not too much); but most importantly, (c) it is not designed to help you get ahead but to keep you from falling behind. Whenever an industry promises that it can police itself, run as fast as you can to that door, slam it shut hard, and bolt it before you let loose those demons!

To quote John Mauldin from his 17Jan2009 newsletter “Thoughts from the Frontline” (you can sign up here): “Allowing banks to go to 30:1 leverage based on ‘value at risk’ models and other financial wizardry that clearly neither the banks nor the regulators understood, was simply bad policy, and we are paying for it. As Woody Brock so wisely notes, 30:1 leverage is not three times more risky than 10:1 leverage, it is 25 times more risky… As an aside, many European banks were even more highly leveraged.”

Ah, the good times are just now beginning… and if you think I won’t criticize Obama for his economic recovery plan, wait for it.

ACTION: After the most difficult financial kidney stones pass (in 2-3 years), reinstate portions of the Glass-Steagall Act that were gutted by the GLBA.

Gluttony painting Largesse Looms Languidly   Weight Loss Lane sign

Let’s face it. Over the past 8 years, some of our commercial institutions have been gluttonous pigs (and let’s not even bring up Bernie Madoff). It’s going to take some time to wear off all that excess weight. Before the (arguably) criminally-negligent GLBA was passed in 1999 by a Republican Congress hell-bent on keeping the Tech Bubble going, financial stocks made up less than 8% of the GDP. This April 2008 ETF Sources article pointed out this has happened before: in energy stocks in the 1980’s, in tech stocks in the 1990’s, and now the financial services sector joined at the hip with its Siamese twin, the housing bubble.

As Jack Hough noted in his Stock Screener article in the Dec. 2008 issue of SmartMoney, (p. 40):

o  “Financial stocks have fallen from 22% of the value of the S&P500 index two years ago to about 16% today. We’d get on fine if they were below that.” Personally (Gar here), I’d be happy if we cut that back to under 10% again and re-founded the manufacturing sector in this country, but Santa has already come and gone for this year.

o   “Market recoveries can take much longer than you think. The one that followed the Great Depression took 25 years. From January 1973 to December 1974, stocks fell 42 percent. It took 16 years for them to hit a fresh high.”

o  “Fat yields—not skimpy P/E ratios—are the best signal that a bear market is bottoming. In recent history that has happened when index yields rose to 5% to 6%. The S&P500 [by comparison] now yields around 3%.”

Ergo, we’ve got a ways to go. My best hope is that we will cycle sideways for the next 12-15 months, possibly bouncing between 8800 and 7000 on the Dow. I’m still working on some charts that I’ll try to put in a future “Road Signs” installment, so those figures are still loose. But I am in no doubt that this will be a protracted painful period for all investors.

ACTION: When the market bounces back, use that opportunity to trim some of the dead weight in your portfolio. I believe we still have farther to fall before any real recovery can begin. More on that later.

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