Flavor of the Month

August 21, 2008 by  


By Bob Wood, MMNS

As I write this column in mid-August, we are witnessing quite an amazing series of events in the U.S. The dollar is rallying despite the multi-billion dollar financial bailout schemes initiated by our Washington leaders, as unpaid liabilities in Social Security and Medicare obligations continue to ramp up. The domestic stock market is rallying regardless of bad underlying fundamentals. And while we are sending troops into a foreign country as an offset to forces already positioned there to defend interests of another nuclear power, Russia, oil and gold are headed ever lower!

Does any of this makes any sense at all? While none of it seems to mesh for me, Wall Street and the financial media find no shortage of justifying rationale to call all these events bullish for stocks. I do not share this enthusiasm, not only because their rationale makes no sense to me but also because these short-term trends and developments will, undoubtedly, not last very long. Let’s look more closely at what we’re hearing as justification for the dollar’s current rally. It seems that economic activity has slowed in Europe, meaning that its central bankers will elect to withhold raising interest rates any further, and they may decide to cut rates, as the U.S. has done, to combat recession.

We heard this past week that U.S. headline inflation is running at a 17-year high, and, with inflation raging around the world as well, why would central bankers think about cutting rates? And if they did, what support for their currency could be expected from the markets? Weren’t low interest rates, in large part, the cause of our inflationary environment in the first place?

Another popular rationale to explain the rising dollar is that America was first to see falling economic activity, with Europe and Asia following our lead. So, the logic goes, first in means first out. So that, I suppose, indicates that since our economy was the first to slow, we will be the first to enjoy a recovery.

That’s it? That is ample reason and justification to explain the rising dollar?! Wouldn’t that case be stronger if accompanied by something a little more substantial? Does this imply that the root cause of our economic woes, the cratering housing market, will rebound soon, in spite of the dismal Spring/Summer selling season, which shows sales ending as badly as they did last year?

To me and others who demand stronger cases for investors, the housing market shows no signs of rebounding any time soon. With lenders now demanding tough underwriting standards for potential borrowers, demand must, by definition, be lower than it was during the boom years. Add to that the difficulty owners find in selling a home and how many buyers must sell before they can buy another home. So what’s the real outlook there?

One realist who has been consistently right in his bearish predictions for housing is Nouriel Roubini, Professor of Economics at New York University. He made his case for the housing outlook in a recent interview published in Barrons Magazine. He contends that far larger losses are coming for investment banks and brokers due to the housing depression and losses in value for mortgage backed securities.

With big brokers needing to raise capital to offset their multi-billion dollar losses, much less money is available to fund economic growth plans. With so much money needed simply to cover massive losses on bank and broker balance sheets, how much will be left to lend to businesses looking to expand?

Next, let’s look at the automobile market. How much hope exists that any of our major domestic auto makers will survive in their present forms? Job losses have wrecked entire communities where workers have lost the last remaining high-paying manufacturing jobs. Overall, U.S. wages are still falling in real terms. So what will power consumer spending going forward?

And let’s not forget the falling job market, now that we’ve seen job losses every month so far this year. Which U.S. industries are poised to generate hundreds of thousands of job openings? In short, what rationale are we hearing that can be substantiated with solid evidence? Essentially, I hear no substantiation at all!
Instead we are fed nonsense such as how we’ll automatically recover faster than other nations around the world, regardless of experiencing the worst economic developments in recent memory. If Professor Roubini is correct again — and he was right all along, while Wall Street tried to convince us that the entire mortgage mess would prove to be contained and would not affect the larger economy — conditions in this country are going to get a lot worse.

Roubini offers solid analytical work to justify his predictions, while Wall Street and the financial media offer us “flavor of the month” explanations. The justification we hear for any rally always seems to wither away as each new rally fades and fails. And fail those rallies will as the worst of the mortgage mess develops in coming months.

Even if market promoters were right in their view that our economy will recover first, so what? With the S&P 500 selling at premium valuations, how much upside potential exists? With other developed markets selling at much lower valuations, recession appears to be more appropriately priced into their shares of stocks. Not nearly so much can be said about valuations in the domestic market.

Of course, if the dollar rallies, if oil falls steeply in price, or if we see the Dow run up yet another one-day, 300-point rally, Wall Street will be quick to paint any of them as a good sign of things to come. We’ll hear that we have all the more reason to follow their lead and buy whatever stock appearing on their Super Duper Focus Must Buy in Bulk list for that morning.

Didn’t we see enough of that false enthusiasm during the bear market cycle in 2000 through 2002? With the stock market, as evidenced in the S&P 500, having earned investors nothing in real terms for the past decade, Wall Street is obviously in dire need of something resembling good news to keep investors in the game.

They’re very good at selling hope, but for investors, to what end? How many failed rallies in the past 10 years have been preceded by bullish pronouncements from big brokers, fund managers and anyone getting air time on CNBC?

Of course, they’re not about to tell us the truth if it means seeing the domestic stock market with little to propel it higher in coming weeks, months or years. And with that point so obvious, why do investors continue to listen to them and gobble their “flavor of the month” justification that the good times are here again?

Have a great week.

Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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