The question on everyone’s minds is: What can we expect in 2010?
Well, that depends on how quickly, slowly, recklessly or carefully the government can let the air out of the optimism bubble we’re currently experiencing.
For example, the current market optimism is the perfect opportunity for the government to allow some of the “cleansing” to occur. Yet, they haven’t been taking much advantage of it, as they are seemingly still too frightened about what they were facing way back in 2008. They are still in “prep mode.”
But putting off the (nauseating) cleansing process of borrowers giving up homes they simply can’t afford and banks fully facing the disastrous bets they made on a real estate bubble, only prevents us from allowing money to flow freely through the financial system.
I’m tired of reading (and writing) about the fact that the government is assisting banks in hiding the pent-up surge in foreclosures. That’s old news. Now we have to focus on how, why and when they will allow some of the chips to fall, and how to turn that into profits.
How Fast is Too Fast?
Let’s start with wrapping our heads around the situation at hand.
If the government lets out the optimistic air too slowly, our economy may feel like it’s trying to run through a swimming pool. But the government is more interested in trying to make the landing as soft as possible, no matter how much that slows down the country’s progress.
Personally, I don’t believe the government can possibly time these things so well as to significantly reduce the odds of another very sharp sell-off in the next year or so. At some point, the jugglers will have to drop the balls … or knives.
If they take a long time to face the music (and that’s what they are going to do), investors will assign lower P/E ratios to stocks (as markets come to expect slower growth) — slowing or killing their gains — and other global economies will charge forward on a relative basis. But, as they said on “Seinfeld,” “Not that there’s anything wrong with that.”
How to Sell it to Constituents and Wall Street
This is going to be a question of how to fully reckon with disastrous bets that are still on banks’ (and the government’s) balance sheets, while not smashing the equities market.
Why do I seem to point this discussion at the government?
Well, first of all, the government and the banking system are partners — period. Banks rely on the government to enforce limited regulation and more bailouts (bailouts that now come in many new forms that are not as detectable by the average Joe). The government is where the regulation will come from, and “regulation” is often just another word for “honesty.”
Let’s take a look at how “honest” is supposed to be defined. I rather like the third definition best:
Honesty:
hon·es·ty [on-uh-stee]
1. The quality or fact of being honest; uprightness and fairness.
2. Truthfulness, sincerity or frankness.
3. Freedom from deceit or fraud.
The government (with your tax dollars) will continue bailing out the banks and buying up lots of mortgage-backed securities itself.
At the same time, they will continue to prepare for possible financial Armageddon with cute and quiet maneuvering like how they lifted the $400 billion financial cap on the money it will provide to keep Freddie Mac and Fannie Mae afloat on Christmas Eve when nobody was looking.
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What Happens When the ‘Big Boys’ Want to Make a Big Move?
As I wrote last week, the current problems we are facing make the September 2008 stock market look like a walk in the park. But the government seems to think the problems can be absorbed by the markets gradually. The fear was that we would have to absorb the problems quickly — like trying to swallow a pill the size of a hamburger.
Think of it like this: If I’m an institution (like a large hedge fund) that owns 9% of the stock in a company that I want to sell, then I would have to distribute the shares when there are buyers available. Otherwise, I would knock the market down.
So when institutional investors are faced with this problem, the routine is to sell when the buyers are still there (i.e., not wait for “the top” or the new decline).
And, often, the institution will even go around touting the stock (or calling in favors for others to tout the stock) in order to create the market.
Is this wrong?
I don’t know. I happen to lean toward the notion that this is simply how markets work, so I’m fine with it.
Whether you agree with it, or somehow convince yourself that this turns you into a victim (as opposed to someone who didn’t do his or her homework), this is how it works. So, you must get used to it and get on the right side of the trade.
But my point is, this is what the government is doing right now. Only thing is, it owns a lot more than 9% of the “stock” in this “company.” It’s more like unwinding a position that equates to 80% of a company’s stock.
Bad News in Bite-Sized Pieces
What the government has to do now is “distribute” the bad news a little at a time.
But like institutional investors who don’t sell just 1,000-5,000 shares at a clip — they still sell large enough amounts of stock that push the price down to some significant degree, but not enough to “crash” the stock or spook investors — the government can’t possibly massage the bad news enough to avoid panics along the way.
The question is, how skillful can it be at balancing the horrible numbers with market sentiment?
When market sentiment is bullish (which is often just a reaction to advancing markets, aka, other bullishness), it’s best for the government to announce as much negative news as it can.
But they can’t just dump it on us all at once.
When market sentiment is bearish, that’s when the supply side (of facing our problems) outweighs the demand side (of optimism), and that’s when the government will try to apply the pig’s lipstick again.
The debate is about whether we should finally face the music and suffer losses, or cleanse the system at a faster pace and get it over with … and how fast “too fast” (and “too dangerous”) really is.
Is There a ‘Just Right’ Dose of Reality?
As I said in the beginning of this article, it seems the government believes the only course of action that would work (given the size of the problems we have) is to let us digest bad news little by little — just like the big hedge fund that has to unload a big position.
So, as you trade the stock market this year, keep in mind that there is a big seller out there “of recognition.” Hopefully the government can be as smart a seller as the hedge funds usually are.
We shall see.
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