Hedge Fund managers speculate with worker pensions. If the investments work, the hedge fund trader makes a small fortune off a lot of people, which all adds up to unfathomable riches. If the investments fail, the hedge fund closes its door and investors are left to pick up the pieces. Hopefully, there are pieces left.
Citigroup’s derivatives traders used FDIC insured and government subsidized capital to speculate on indexes moving this way or that, collecting multimillion-dollar salaries for their guesswork, but when the guesses went wrong the industry pleaded “too big to fail” and required a taxpayer bailout in order to remain solvent. Now that the liquidity crisis is past, the trading desks have returned to putting on one-sided trades for which they will either receive spectacular financial rewards, or the bank will be back at the till.
Which brings to mind the old expression, “fool me once, shame on you – fool me twice, shame on me.”
This week, we entered the height of earnings season. Because of the stunning market rally off of March lows, the talking heads are feeling bullish. Most seem to expect a typical economic recovery, in spite of the facts. Instead, to me it looks like the earnings have improved, but “recovery” is still a long way off.
Several financial stocks reported earnings this week. The big Wall Street firms reported very strong profits, because their trading desks have been busy gouging customers in the midst of one of the strongest back-to-back market rallies in history. Furthermore, it’s not just stocks that have done well, but the bond desks are making a mint as well. These profits, however, have virtually no predictive power of future earnings potential.
On the other hand, in core competency areas (away from the shiny new market rally), loan loss provisions continue to climb – which is an indication that consumers are still feeling pressured, even if Wall Street has already “moved on” past the economic debacle it helped cause a year ago.
After the “cash for clunkers” activity this summer, consumers are settling back into a more cautious outlook. The ABC News Consumer Comfort Index fell two points to -50, which is the lowest level its been in three months and is only four points higher than the record low it set last January. Mutual fund flows $7 flowing toward bond funds for every $1 that investors put into stocks.
This market is not caused by a horde of investors flooding into the market, afraid of being left behind. The rally is simply caused by an absence of selling. A year ago, investors were bailing out at any price, and prices fell to the point where new buyers could be lured into the market due to cheap valuations. Today, the massive dumping of stocks is (for now) a thing of the past. Prices have stabilized, sure, but we’re not seeing much net new money being invested in the market. Investors, like consumers, are cautious. Only headline writers and politicians think that the coast is clear.
Consumers drive this economy. While the industrial side of the economy is benefitting enormously from the declining value of the dollar and a rebound in China for technology and basic materials, it is hard to imagine the broad U.S. economy, or market, from doing well until U.S. consumers have found a way to reduce their debt burden. Parts of the market may do well, but consumer spending makes up about 70% of economic activity, so if consumers are feeling strained, it is hard to imagine the rest of the economy somehow pulling off a typical economic rebound.
Savers' balance sheets are being ravaged by the low interest rates that Wall Street is paying on savings accounts. The Obama administration wants to give certain seniors a $250 stipend to help them through tough times. Why not raise short-term rates so that all savers can earn a decent return on their life savings. It's not like the bankers are actually loaning anybody money with the artificially low savings rates. The Fed needs to restore some normalcy to the economic environment. Paying savers a reasonable return on their investments, though it might hurt Wall Street earnings prospects, would go a long way toward helping main street retirees recover.
As a result of the difficulties we see, we remain pretty selective in what the portfolio owns. Our commodity investments have done well as oil prices recover to the $80 level. Our technology stocks are enjoying true earnings growth. Our high yield bonds look increasingly sound as the companies that stand behind the debt de-leverage balance sheets and investors in the bonds collect high coupon payments as we wait to see whether a real economic recovery is around the corner or not.
We have invested some internationally, where consumers are not as tapped out and where politicians target economic growth rather than redistribution. And we have a bit of cash, too. We have too much cash on some days – and too little on others.
We would like nothing more than to put last year’s crisis behind us. At this point, however, it seems more like the eye of the hurricane than blue skies, forever.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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