Friday, December 16, 2011

The Morning Call--How much bad news is beng discounted?


We received three dynamite economic numbers yesterday--weekly jobless claims (lowest in three years) as well as the both the New York and Philadelphia Fed business surveys. However, all was not rosy. December industrial production was disappointing and the PPI data was mixed. As I am sure you appreciate, employment has become one of the most significant stats of late; so yesterday’s strong report was investors’ initial focus. As a result, stocks began the day on a positive note.

And I will add, for good reason. Our economy may be recovering at a below average rate; but it is recovering. Reviewed from the perspective of what the rest of the world is doing, it is once again proving its capacity for resilience. I am not getting all jiggy here; but economic conditions appear to be forging ahead in spite of our incompetent political class, the inability of the EU to properly address their crisis and slowing activity in the emerging markets.


Unfortunately, investors only got about an hour or so to enjoy it. Mid morning Christine Lagarde, new IMF head, in a speech in Washington basically said that (1) no country was going to escape the affects of the coming EU sovereign debt debacle and (2) those affects would be comparable to the 1930’s. What a party pooper.

Of course, she is probably right on the first point. Indeed, our Model already has the impact at least one sovereign default. Moreover, I have stated repeatedly that one of the two biggest risks to our economic forecast was an EU disaster scenario. The issue for me is that if I know it, then how many other people in the world do you think also know it? My point being that Lagarde could be correct on this issue; but it may already be in the price eggs.

As far her second argument goes, even if we assume the first point is a given, the question is whether she was serious or was she campaigning for more US assistance for Europe?--knowing that US public opinion is dead set against a European bail out. Clearly, I don’t know the answer; but I do know that there is no way in hell, Bernanke will commit the errors of the 1930’s Fed. Further, given the gridlock in Washington, it will be mid 2013 before our Congress could make the same mistakes (raising taxes and cutting spending) of the 1932-33 congress even if it wanted to. And while they might cut spending or raise taxes based on which party wins in 2012, I don’t believe there is much chance of getting both.

That is not to say that the euros won’t make those mistakes. In fact, they already have. The ECB is tight and, as you know, austerity is being imposed across the continent from above--which are a couple of the very reasons an EU debacle in one of the big risks to our forecast. On the other hand, as I have noted repeatedly, the eurocrats have a history of walking up to the disaster line, sticking their nose over it, then backing off and doing what makes sense. That doesn’t mean that they will do it this time; but there is some probability that they will. So we can’t automatically assume the worst case is a slam dunk; nor can we assume that even if the worst case occurs that it isn’t already largely discounted.

The EFSF is useless (medium):
http://www.zerohedge.com/news/revised-efsf-draft-shows-italy-spain-responsible-one-third-european-bailout-funding

Is the euro on the brink of collapse (medium):
http://www.ritholtz.com/blog/2011/12/is-the-euro-on-the-brink-of-collapse/

Bottom line: Europe seems to be headed for another crisis sooner probably than later; and unfortunately, the rhetoric out of the eurocrats indicates that they are currently unwilling to face that fact. So it is small wonder that investors are worried. But not to beat a dead horse, this is not exactly new news. Indeed, the media is filled with dire predictions of depression, revolution and war that will result from a collapse/disbanding/mass debt repudiation in Europe. And while they may be correct, that would mean that for stock prices to be at current levels, most investors are na├»ve, stupid or just don’t care about the money under their care. I just don’t buy it.

Yes, I think that conditions can and probably will get worse in Europe. Yes, if the worse case happens, it is not reflected in our Models. But I believe that in the end, the worse (near term) case (populations working harder, getting fewer freebees, banks defaulting and being recapitalized) is not only the best case but will be less painful than the current multitude of Cassandras would have us believe. And while I may have to revise downward my economic forecast, stocks at the close yesterday are 9% undervalued based on an already dismal economic outlook.

As I said yesterday, I don’t think this means we load up on stocks. I am simply arguing that there is a decent probability that the October lows are as bad as it will get.

This article shows just how worthless Wall Street stock ratings are (medium):
http://www.bespokeinvest.com/thinkbig/2011/12/15/a-look-at-analyst-ratings.html




Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.