Sunday, May 21, 2006

News Flash---the market is down and everybody knows why?

After eight painful market days, on Friday everything flattened out. Friday's performance was not particularly reassuring, but perhaps it contributed to this weekend's sunny and pleasant weather. But as hurricane season approaches few pundits dare to be optimistic. That may be good news.

Everyone seems to know why the market is down. The reasons are: U.S. inflation fears; the trade deficit; the current account deficit; more interest rate hikes ahead; a possible housing market bust; the precipitous decline of the dollar in the last two weeks; the persistence of high energy costs; economic slowdown ahead; an expected correction of a bull market run; hedge funds reverse course; more sellers than buyers.

Simple, right. I feel like Dr. House trying to come to a diagnosis. Every reason is based on observable facts or historical trends. It's all interrelated. And to complicate matters, much of the information has been observable for months while the market continued to perform well. What is the real precipitating reason that Dr. House always finds with 5 minutes left in the program. I know the answer.

Several weeks ago our Federal Reserve Chairman, Ben Bernanke, gave material market information to CNBC's Maria Bartiromo at a social function. Yes he did. As the market at that time widely interpreted his and the entire Fed's recent comments as signaling at least a temporary pause in interest rate hikes, he told her that the market view was not so accurate(I don't know the exact words of course but she reported it the next day and there was no follow up from the Fed). The markets reacted in a significantly negative way.

So our Fed Chairman is not alert enough or savvy enough to know the basic rules of market communication. If any corporate executive in the U.S. gives one-off material information to anyone that then moves the market in their stock, Regulation FD dooms them to weeks or months of less than pleasant interaction with the SEC, new job insecurity, possible fines, in the worst case jail, and their company will be assaulted by litigation immediately. The Fed strictly guards their interest rate and formal announcements and disseminates them broadly. Informal remarks, however, also need care. But the point here is that with all of the possibly serious reasons for the recent decline, how can the market be confident that Bernanke can deal with any potential crisis. He can't even deal with a social event. Impersonating Dr. House, that was the spark that lit the fire.

Is this a tongue in cheek analysis? Not completely. Among all of the observable issues, the one that is most troubling as a negative catalyst is the almost radical decline of the dollar in the last week and a half. A dollar rebalance affects everyone and everything, which helps account for the decline in virtually all equity markets, not just U.S. As the market regroups, everything with gains, for example commodities, temporarily comes under pressure.

Heading into this coming week, it is not possible to know where we are until the fire is out. Then the damage can be assessed. I remind myself that U.S. corporate earnings growth remains strong. The S&P 500 p/e ratio is today at its lowest level since 1997 so by standards of the last decade it is certainly not overvalued. If this fact is not validated in the market's action next week that would be worrisome.

And be careful Mr. Chairman. If you do need to say something to be pleasant and responsive, then smile, make eye contact, and make your comment so obtuse that no one can figure out what you said. That is what your predecessor did.


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