Wednesday, May 6, 2009

The market that defies gravity

I feel like I am beating a dead horse and I continue to be wrong in my bearish outlook on the market, but the resilience of this recent rally has been astonishing. I am not a market timer or trader. I do not speculate on the direction of the market. I have been hedging my equity positions since November of 2007 and recently have sold most of my common stock portfolio. As Oaktree Capital's Howard Marks has said so eloquently, the duty of a portfolio manager is to protect capital and manage risk. I was afraid of suffering permanent capital impairment and I subsequently pulled most of my money from the market before this rally went into hyper drive. I was comfortable not participating in any upside to protect against what I saw as significant downside risk, even after the market's large fall in February. The funny thing is that aside from some green shoots and second derivative positives the fundamentals seem to have gotten worse as the rally has gained steam. I think this morning provides a perfect example of why I am comfortable on the sidelines, irrespective of the seemingly unabated march upward of the S&P.

This is what I woke up to this morning in the Wall Street Journal:

1. Bank Of American may need $34B in capital
This is fantastic news. Based on a stress test in which the "worst case" scenario may end up being the base case one of America's largest banks needs $34B in additional equity capital to shore ups its balance sheet. How much does B of A need in a more draconian scenario? Despite the fact that the conversion of the government's preferred shares would be massively dilutive to existing shareholders, the stock is up 8% as we speak.

2. SEC opens up an insider trading case on CDS and is suing the people who let the Reserve Fund break the buck
Bzzzzzzzzzz. You know what that is? That is the alarm clock that went off at the SEC after Chris Cox left. The SEC is apparently awake. That "Gone Fishing" sign dated March 2005 is no longer hanging in the lobby at the SEC. Does this mean the blatant insider trading we have seen prior to big M&A deals is going to get prosecuted? Somehow I doubt it but I would say that the SEC being awake is not necessarily a good thing for the market manipulators who have likely had a hand in this recent rally.

3. Fed Directors' Ties to Banks Spur Calls for Changes
This is an ongoing story (see my post entitled Simon Johnson Continues to be Proven Right) and it looks like I was not the only person who thought this whole thing was a bit shady. Usually, blatant impropriety by the head of the most prestigious regional Fed bank might spook the markets. But, we have become so used to conflicts of interest between Washington and Wall Street that we don't even bat an eye anymore.

4. 20% of homeowners are under water
According to a study by the recent drop in housing prices has left 20% of homeowners under water on their mortgages. One of the first things I learned in my real estate law class at Wharton is that people have a put option on their mortgages if the value of the house drops below the face amount of the mortgage. People can just walk away. The last thing we need is more foreclosures and falling house prices.

At Fallen Mortgage Titan, Tragedy Amid the Turmoil
This is the story about the acting CFO of Freddie Mac committing suicide and the surrounding speculation that the pressure of his uneviable job was one of the reasons that he took his life. If this is not indicative of the state of the housing market and the public sentiment in the US right now I am not sure what is.

Needless to say the headlines this morning were depressing from a stock investor and macro economic standpoint. Too bad I am not invested in stocks right now. If I were, all of these negatives might not bother me at all because I would be richer. Believe me, it is not fun to be one of the last remaining Cassandras in the market. But, I learned very early on in my investing career that if you do not have conviction you should be on the sidelines so you can live to fight another day. I just hope my day comes before the S&P gets back to 1400.