The “Yes, We Can! Market” 
  Monday evening, July 27, 2009

            In our July 15 posting, we indicated our growing doubt that the 950 area of the S&P 500 would be the impregnable top of the cyclical bull rally that started earlier in the year.  Recent days have confirmed that; but they have decidedly NOT convinced us that it is time to be more aggressive.  At the least, we choose to wait until the grossly overbought condition of stocks changes.  At worst, this move of the last several days will be a failed break-out, every bit as much as the technical formation of just a few weeks ago (the head-and-shoulders formation we wrote of) also proved to be a bad signal.

            We have not yet seen all the indications that would make us comfortable with the idea that the market AT THESE LEVELS is safe to trade into (perhaps some will take that as a contrarian signal and outsmart even us!)  As we’ll comment on briefly here, we believe that, more than ever, the ongoing cyclical rally is being “built” on sand, rather than on sturdy ground.  We call it now the “Yes, We Can! Market.”  The force of will, blind faith and gobs of cash burning a hole in their pockets are prompting a few more souls to put money “to work” even if some—as Art Cashin quipped on CNBC this morning—have to hold their noses while doing so.

            Helping the stock market (and commodities, which have dutifully joined the charge higher amid the nascent belief that a “recovery” is coming) avoid any kind of an interruption to its good fortune last Friday was Warren Buffett.  The Oracle of Omaha told CNBC that he still doesn’t see any signs of life out there in the economy; but since “The market is very, very likely to turn up before business,” people should buy stocks anyway.

            Now, there is no getting around the fact that Buffett is one of the best value investors who ever lived. However--and, to his credit, he readily admits this--he is no market timer and does not want to be one. This, in our humble opinion, does not serve his Berkshire Hathaway shareholders well--especially now. For we are not in a “normal” environment, nor will we be any time soon.

            Buffett also demonstrates by comments such as last Friday's that he has virtually no understanding of how our fractional reserve banking system works. For the most part, he seems to believe that--even though the degree to which the economy shrank recently was worse than most postwar “recessions”--the pattern of expansion, to a peak, to recession and to a new recovery/expansion still works.

            It does not. Indeed, it CANNOT.

            In the past, economic expansions were driven by a number of things. Wise fiscal policy. Monetary easing--meaning either lowered interest rates or an expansion of new available credit, or both--as needed. The right political environment meaning, generally, that tax and other policies did not unduly impede growth and consumption. Last but not least, you had a middle class willing and able to buy homes, new cars, etc. due, at least in part, to rising wages and a rising living standard.

            At times, things got a little “overheated.” Too much of a good thing--at least, in our fractional reserve system--leads to rising prices and other imbalances. Once expansion turns into an overheated economy with its attendant speculation, the Federal Reserve would usually “take away the punch bowl.” It would raise interest rates, tighten credit conditions otherwise, and generally seek to take the economy from boiling back to a steady “simmer.”  Now and then, it would either overdo things or other factors would creep in--and we would have a recession.

            Finally--and it is critical to keep in mind here that, after all this, there would be considerable “pent-up demand” on the part of consumers and businesses--it was time for the cycle to repeat. The Fed would start lowering interest rates again, conditions would ease, employment would jump, and the economy would have the ability to expand anew.

            When Buffett and others suggest the cycle will soon (even if slowly) repeat itself, they seemingly fail to understand a few things. Most of all, the current recession did not come about because of tight monetary conditions. Quite the contrary; it came about because of the reckless use and abuse of cheap and plentiful credit by EVERYONE from Joe Sixpack to the heads of banks and hedge funds. Joe and the rest of us ALREADY have all the crap we need. There is no pent-up demand! Instead, there is both the need and the desire--galvanized by a rediscovered, cold reality—to SAVE rather than spend.

            The Bernanke Fed has already employed easing credit conditions, taking interest rates down to nothing and unleashing fleets of helicopters to shower one and all with new credit. Though these steps (together with the chicanery of suspending mark to market rules and all the rest) have helped to shore up banks and finance companies, they have done next to nothing for Middle America.  This is because (as we explained to you in the June issue) banks have used TARP and other funds to help themselves; not to help Joe.  In any event, even if the bank was willing to lend Joe some money, standards have changed.

In short, the idea that non-existent pent-up demand—and, thus, a new recovery or economic expansion—is going to be enabled by considerably more stringent lending for a population whose income is less and whose living costs are rising is absurd.

            Nevertheless, the shills on Wall Street and those on CNBC (such as Larry Kudlow and his channeling of Monte Hall, and Jim Cramer with his channeling of Bobcat Goldthwaite) have taken the “Yes, We Can!” attitude. Now, we certainly know enough to realize that most of these folks are in the sales business for the financial industry, and--while genuine news and facts that get reported are certainly welcome--we must take their commentaries and sales pitches with a couple of pounds of salt. Lately, though, their contortions and twisting of even the news has grown increasingly absurd! No honest and unbiased person can, for instance, point to “good numbers” from a Goldman Sachs—ones made possible by government injections of credit and accounting sleight of hand—as a harbinger of great days ahead, while minimizing a Capital One when the latter reports genuinely BAD numbers due to the WORSENING woes of American consumers.

            One of the silliest bits of “reporting” of recent days came this morning. It was reported that there was an unexpectedly large jump in new home sales for the month of June. This was quickly seized on by Monte (oops—we meant Larry) as confirmation that last week's report that sales of existing homes also rose shows that the “bottom” for real estate has finally been reached. Gushed Larry (and we paraphrase just a bit), “Tell me that that isn't the most bullish news you've ever heard!”

            Well, it might approach that--if that sales level had not been enabled by a 6% PLUNGE in average prices in just ONE MONTH!  Indeed, don't forget that we are presently in the time of year when real estate historically changes hands at the fastest clip anyhow.  That prices were effectively marked down 6% from May to June--and a big tax credit and other incentives also came into play--in order to have what by historical standards (given the time of year) was a very UNimpressive rise in sales is hardly bullish. To the contrary, it tells us just how weak the economy (and the housing market) are, and will remain for some time.

            If stocks can continue this cyclical rally--prospects you will read a bit more about when we get the latest issue posted finally in the next few days--it decidedly will NOT be due to legitimate harbingers of a new economic expansion. Rather, it will have come about from a witch’s brew of liquidity, hope, ignorance and the like. It will be because enough investors put as much faith in the current “Yes, We Can!” mantra coming from Wall Street as a majority of voters did in last November's “Yes, We Can!” presidential candidate.

Speaking of the latter, Alan Abelson quips in this week’s Barron’s that, “…Mr. Obama is big on rhetoric, not exactly generous with details and short on action…” At SOME point—and we know not when--investors will come to the realization where Wall Street is concerned that more and more people are arriving at where the 44th president is. The “details” of legitimate growth will be lacking, and will undermine the rhetoric.  The action needed to stoke the economy—namely, more Americans back to work, and at rising wages—will be in short supply, if it exists at all.  Then the rhetoric will no longer be believed, and investors will realize that they’ve been duped again.

            For all the good intentions, hopes and ideals, you can't beat simple mathematics.  If we’ve not reminded you recently, PLEASE go back and read (or re-read, as the case may be) “Understanding the Game” to realize WHY we are in for a generational “unwinding” which is still much closer to its beginning than to its end.

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