Saturday, October 25, 2008

U.S. Stocks & A Concerned Populace

I was answering a general question on another board, when vista decided to install an update on my PC and reboot. My blowhard, wordy response was lost. Since it's a general question I see frequently, I'll attempt to recreate my arrogance here on this medium, since blogger has autosave :)

the question (edited slightly):

"Anyone care to share their thoughts on this debacle? I have lost over 40% of my portfolio and need to decide whether I should pull out at the next rally or hang in while things go back up.

In 1929, the stock market fell by more than 80% over 3 years. Is today's market a repeat or will various measures in place stop that from happening again.

Will the emerging economies rescue us from the downward momentum? And can a company lose 80% of its stock and still function? I mean stock value is not an integral part of a company, is it?

I think (please enlighten me if wrong) it is a collective idea of the company's worth which goes up and down according to the collective's sentiment. Therefore, stocks could go down 80% and the companies would still exist but the stocks would be worthless. Is this a fact? What would you do and why? "

three things:

1.) there's a difference between investing and speculating
2.) it's the credit markets not the stock market
3.) a "random walk" -- I'm calling "b.s."


first, there is a difference between investing and speculating.

most people don't like the word "speculator", but if you are buying with the hope of selling later at a higher price (or vica versa) you're speculating.

if you are buying a stock to harvest the dividends (or hoped for divvies) for life you're an investor. ditto with houses -- flipping is speculating and landlording for rent or farming is investing, imo.

the reason that BOTH (and alot of other 'assets' are overvalued is because they only make sense as speculations, not investments. therefore there is no fundamental floor under the price of these items when/as the sh&t hits the proverbial fan.

i have developed a bias against stock speculations primarily because of what i've seen in the corporate world, and money-management world. corporate management was allowed OBSCENE pay and benefits packages due to a large percentage of stock owners being institutions. the money management/pension fund world (with a few notable exceptions) has been very lax (along with government) at rooting fraud, deceiptful practices, and looting of organizations by managments, in concert with boards of directors -- those supposedly tasked with overseeing their behaviours on behalf of the "owners" -- the shareholders.

this charade was allowed to continue -- along with the residential real estate bubble -- and the private equity investment farce -- by really really lax global credit standards and the liquidity that followed. (as we've discussed here and everyone "knows" by now).

A stock can continue to function with it's stock at or near zero. after the IPO, most companies can function without access to the equity markets. many (today) cannot function without access to the credit markets however. a stock price near zero, in most cases, will be a reflection of the company's ability to function -- which at times will be dictated by access to credit. credit market is the dog, equity market is the tail, as Karl Denninger likes to say.


it's my opinion that the world reached the cusp of "peak debt" -- or max debt.

in other words, we reached the point where the debt overhanding the market was meeting or exceeding the assets' ability to service said debt.

this is/was going on at all levels:


personal: on the personal level, the housing bubble and subsequent deflation is the most obvious example of this. every manner of instrument was developed in an effort to forestall the inevitable, however, in the end, the buyers' ability to service ever increasing mortgages on flat incomes was doomed to fail.

corporate: if you are a speculator, the limits of debt availability to corporations means less m&a activity and probably less levered balance sheets. many many companies have built access to short term, cheap credit into their business models (banks, for instance borrow short and lend long and pocket the difference). lots of other companies, fund the time between getting an order, building it, shipping it, paying salaries (etc) and getting paid on an invoice with short term credit as well. these companies could have problems in the near future (those that aren't already in trouble that is).

government: this is the most disturbing probably. we all know that debt levels in government are insane. but what happened in the last several months is truly disturbing.
as lack of faith (due in large part to lack of transparency in companies' balance sheets) started to seep into the market, the government got into the business of guaranteeing everything.

interbank lending, corporate short term credit, bank deposits, money market funds, insurance companies, etc etc etc.

unfortunately, what this did was create a "vacuum" where people who rely on credit and don't have government guarantees are being starved for money....or having to pay WAY up for it.


well, if you have money to loan, who will you loan it to? well, the place with the highest return for the least risk. so, if you believe that you have a gov guarantee on one class of debt and not the other, you'll migrate to the guaranteed money.

governments, around the world, trying to keep funds from fleeing their country started guaranteeing everything. every other government was forced to follow suit. the problem is, that the sheer volume of debts being backstopped by some of the more marginal countries is beginning to outstrip the governments realistic ability to backstop the debts.

So what's the problem with this?

well, we are running a very high risk of having cascading sovereign debt defaults. if this happens it will only make personal and corporate debt harder to obtain without paying higher premiums.

so, we're effectively living through a deflationary credit unwind -- while the government does everything in its power to reflate -- short of demanding and enforcing truth in balance sheets (including their own) .


a random walk in prices postulates that stock prices move in a "predictably unpredictable" fashion....brownian motion, where each "tick" in the market is detached from the last tick. in this fantasy world we can plot the probability of price distribution in a classic bell curve.


as we've seen, prices are VERY dependent on what has happened in the immediate past. they do NOT follow a standard distribution and trends in motion tend to stay in motion -- in large part because the price move tends to have influences on the very system that is determining the price (reflexivity as soros puts it).

for example, if the price goes down by a lot, people holding that position LONG on margin will be faced with margin calls, exascerbating the downward pressure. same thing can happen in reverse.


I think (and have thought for some time) there is still a very high risk of an equity market crash.

This may be brought about by sovereign defaults, a 'extraneous event' or a butterfly wing -- there's no telling.

I'm selling any pop I see in this market still.

This strategy, like any followed with religious zealotry and/or too much leverage will occasionally get me killed (like today), so please don't consider this trading advice. This is just my way of *finally* answering her question.

I think it's over when median home values are no more than 3x median acheivable incomes (and no looming local tax crunch), and balance sheets are transparent and believable. and to get to that point means a lot more "delevering/pain" in the pipeline.

Aren't those cheery thoughts :)


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