By *ALAN ABELSON* The banks have been the spark plug of this powerful stock-market rally, but past may not be prologue. Goldman’s missing month.
*THE AMAZING RANDI. WE’D NEVER HEARD OF THE CHAP UNTIL* last week, when we were indulging in an old habit that began way back when we were a copy boy (the journalistic equivalent of a galley slave) and took to passing some of the grudgingly little downtime allotted to us poring over the obituaries. Our interest was not born solely of innate ghoulishness, but nurtured also by the fact that an obit provides a highly compressed and often fascinating biography of those noteworthy souls who have recently departed from the ranks of the quick.
In this instance, the subject was not the Amazing Randi, but John Maddox, a British editor of considerable renown who transfigured a stuffy magazine named Nature into a scintillating science journal. Mr. Maddox, by all description an unflaggingly imaginative and energetic editor broadly versed in the sciences, was graced with a flair for the unorthodox and a sharp nose for bamboozle.
Back in the late 1980s, he published a piece by a French doctor claiming remarkable qualities for an antibody he had studied, but only on the condition that an independent group of investigators chosen by Mr. Maddox monitor the doctor’s experiments. Among the investigators he chose was the Amazing Randi (né James Randi), a professional magician whose knowledge of science may have been limited but whose knowledge of hocus-pocus was peerless. The poor doctor’s goose was cooked.
Mr. Maddox’s engaging inspiration got us to thinking, gee, wouldn’t it be great to have an Amazing Randi handy to help uncover the voodoo that has caused investors virtually en masse to suspend disbelief. We’re referring, of course, to their marvelously revived tendency to slip on their rose-colored glasses, which for so long had been gathering dust on the shelf, when viewing corporate fortunes or the economy at large.
Take for example, dear old Goldman Sachs, which has enjoyed a mighty burst of enthusiasm among Street folk that has sent its shares sprinting to the vanguard of this smashing stock-market rally; an enthusiasm, moreover, that has spilled over to other banks and their financial kin. No argument, the firm has handsomely outperformed its few surviving rivals, none of which is blessed with Goldman’s deft trading skills or tight Washington connections.
Goldie reported earnings of $1.8 billion for the first quarter. In doing so, it got a lucky boost from its switch from a fiscal year ending November to a calendar year. The shift came in response to statutory fiat, as part of Goldman’s change to a commercial bank, a prerequisite to gaining eligibility for all those lovely billions in loans and guarantees the government has been showering on banks.
That $1.8 billion in March-quarter profits was a heap more than its analytical followers expected, and, as intimated, a sparkling demonstration of Goldman’s vaunted trading agility (from what we can gather, it made a bundle in part by timely shorting bonds). The switch in its fiscal year took December out of the first quarter and made it an isolated, stand-alone month, relegated to an inconspicuous assemblage of bleak figures far in the rear of the company’s 12-page earnings release.
As it happens, Goldman lost some $780 million in December, a tidy sum that obviously would have taken a lot of the gloss off its reported first-quarter performance. And, who knows, it might have even drained some of the zing that the surprisingly good results lent the stock.
But, in any case, the very next day, the spoilsport credit watchers at Standard & Poor’s threw a bit of cold water on the shares by venturing that, in light of the soggy economy and unsettled capital markets, it would be “premature to conclude that a sustained turnaround” by Goldman was necessarily in the cards.
The financial sector, as even the most cursory spectator of the investment scene doubtless is aware, has provided the crucial spark to this powerful bear-market rally. And, in particular, the return from the very edge of the abyss by the banks in the opening months of this year has revived fast-swelling bullish sentiment.
The question naturally arises: How did the banks, so many of which seemed to be slouching toward extinction, get their act together to the point where they were in the black in January and February?
In search of an answer, we turned up an intriguing explanation for this magical metamorphosis by Zero Hedge, a savvy and punchy blog focusing on things financial. Not to keep you in suspense, Zero Hedge fingers AIG, that repository of financial ills and insatiable consumer of taxpayer pittances, as the agent of the banks’ miraculous recovery.
But not quite the way you might think. As Zero Hedge explains, AIG, desperate to hit up the Treasury for more moola, decided to throw in the towel and unwind its considerable portfolio of default-credit protection. In the process, the badly impaired insurer, unwittingly or not, “gifted the major bank counterparties with trades which were egregiously profitable to the banks.”
This would largely explain, according to Zero Hedge, why a number of major banks actually, as they claimed, were profitable in January and February. But the profits, it is quick to point out, are of the one-shot variety, and, ultimately, they entailed a transfer of money from taxpayers to banks, with AIG acting as intermediary.
Lacking any deep familiarity with the arcana of credit swaps and the like, we can’t swear to the accuracy of this analysis. But shy of conjuring up the Amazing Randi and have him unveil the truth, it strikes us as plausible — and easily as persuasive as many of the various explanations we have come across for the surprising and rather mysterious turn for the better by the banks.
If by chance it proves out, it just might act as a sobering influence, and not just on the financial sector.
*FRANKLY, WE’RE AS BORED WITH THIS BEAR* market as anyone. And we fully understand, after a year of brutal pummeling, the frantic hopefulness with which investors respond to the inevitable bounce, especially when it’s as robust as this one has been.
And we understand, too, their eagerness to grasp at the flimsiest hint of recovery and to strain to put a good face on every twist and turn of the economy, no matter how ugly. But we fear — as some tunesmith crooned long ago — wishing won’t make it so.
There’s nothing obviously wrong when investors, confronted by what seems to be a sold-out market and tired of sitting on their hands, decide to take a fling on a bear-market rally. And it certainly has been rewarding for virtually anyone who a month or so ago did just that. But an awful lot of folks don’t have the time, the discipline, the nimbleness or the spare cash for that sort of hit-and-run investing.
And the danger resides in being carried away by a momentary spate of quick gains and turning a blind eye to the riskiness of the market, which now is a heck of a lot greater, if only because the advance has carried price/earnings ratios to elevated levels — something above 20 on the Standard & Poor’s 500 — or to the critical negatives in the economy.
David Rosenberg of Bank of America/Merrill Lynch (we can’t believe we said the whole thing) last week offered some worthwhile observations on the stock market and the economic landscape that just happen to buttress our own reservations.
He points out that the two groups that paced the sharp upswing were financials and consumer cyclicals, in which there are, respectively, net short positions of 5 billion and 2.7 billion shares. Which strongly suggests that not an insignificant part of the rally has been provided by shorts running for cover.
He also points out that the Russell 2000 small-cap index is up 36% since the March low, and has outperformed the S&P by some 980 basis points. As David says, “the last time it pulled such a massive rabbit out of the hat” was in the stretch from late November to early January, and the major averages proceeded to make new lows two months later.
Another amber light he spots is investor confidence. Over the past five weeks, he reports, Rasmussen, which takes a daily reading, has seen its investor-confidence index surge 32 points, an unprecedented climb in so short a span. This could be, he suspects, a “fly in the ointment for a sustained equity-market rally.”
David has four markers that will signal to him that the economy is finally making the turn and starting an extended expansion. The first is home prices. The second is the personal-savings rate. Marker No. 3 is the debt-service ratio, and No. 4 is the ratio of the coincident-to-lagging indicators of the Conference Board.
Aggregating those four markers, he calculates that we are roughly 44% of the way through the adjustment process. That is a tick up from where we were last month. However, the improvement, he laments, has been very modest and very slow.
We should add that he also stresses that it’s critical for both the economy and the market that payrolls stop shrinking. All the talk about jobless claims “stabilizing” is so much poppycock, he snorts. That number of claims, he notes, is still consistent with monthly payroll losses of around 700,000. As with industrial production, which is also in a vicious slump, employment must stop falling before a recession typically ends.
“Call us when claims fall below 400,000,” he says, which is his estimate of “the cut-off for payroll expansion/contraction.”
Until then, he warns, “the recession will remain a reality. Rallies will be brief, no matter how violent, and green shoots are a forecast with a very wide error term attached to it.”
