If the first half of the Fourth quarter could be paralleled to a hurricane striking in the dark of the night, then the second half would be described as the helicopter fly over the wreckage the next day. In the darkest day of the crisis in October, it was difficult for The Street to glimpse any reliable market indicators. All gauges had gone dark, similar to the experience of driving through a thick fog. As the fog has cleared and the prospects of a complete collapse of our banking and financial systems have waned, one at a time, pundits have restarted their predictive engines.
When confusion reigns, it is wise to take an inventory of what we know, not what we think, or guess, or feel. So what do we know?
1) Financial company losses are the keystone of the problem. If the banks stop losing money, the government can stop propping them up with taxpayer dollars. If the banks stop losing money, they can start lending money again, their stock and bond prices will climb.
2) Financial companies will not stop losing money until the collateral beneath previous loans solidify.
3) Investors are willing to receive near zero return on short and intermediate term Treasuries vs. the 20%+ returns on lower grade corporate debt. This disconnect means that eventually, when risk appetites return and asset values will be repriced.
4) The U.S. Government is flooding the economy with capital from Fed action, bail outs and stimulus spending. This will stimulate the economy from whatever the spending would not have occurred. We will eventually face meaningful inflation over the long to intermediate term. Devaluing the U.S. dollar helps fix the problem since it lowers the impact of our debt. The downside is our diminishing purchasing power of what wealth is left in liquid assets and debt obligations.
I don’t know how long it will take for these known themes to come to fruition. I do know, however, that when they do, they will be key factors int eh valuation of all asset classes once markets do normalize. To not incorporate these themes into one’s investment theories, is to lose PIERspecitve on the moment.