The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Good Evening: After a long period of what could almost be called “fasting”, risk appetites among investors made a gluttonous reappearance today and the U.S. stock market had its best day of 2009. As oversold as equities had become, it might have taken only one or two reasons to set off today’s feeding frenzy, but I counted at least five. 1) Citigroup said it was “profitable” for the first two months of ‘09, 2) Chairman Bernanke reiterated the Fed’s commitment to supporting the U.S. banking system, 3) Treasury Secretary, Tim Geithner, repeated his previous promises that a buyer of toxic assets is on the way, 4) the SEC promised to review the uptick rule for possible reinstatement, and 5) Jeremy Grantham joined a growing list of former bears advocating a more positive stance toward equities. I will start by offering a brief recap of today’s market action before touching on each of the above factors that helped investors rediscover their risk appetites. I will conclude with an opinion about the staying power of today’s powerful move higher in stocks.

Stock index futures were pointing well north of unchanged even before most of today’s news stories hit the tape, but the story about Citi and one of Chairman Bernanke’s more forceful speeches in recent memory helped propel stocks to what can best be called the “lift off” phase of a rocket launch. The major averages were up approximately 4% within the first 30 minutes of trading, and the S&P 500 made short work of technical resistance at the 700 level. The upward trajectory leveled off once the gain in the S&P approached 6% at lunchtime. Stocks then went mostly sideways until the final hour, which is when the Grantham and “uptick rule” stories provided a final lift to share prices.

The Dow “lagged” by advancing less than 6%, but both the Russell 2000 and Dow Transports each posted gains of more than 7%. Treasurys were under pressure all day, and yields rose between 7 bps and 16 bps. It should be noted, however, that credit-sensitive fixed income securities seemed to confirm the equity rally by outperforming government securities. The dollar was down 0.6%, and commodities were of two minds. The ag sector ramped higher, but losses in crude oil and the precious metals were the deciding factor in the CRB index’s modest 0.4% decline.

In the first two stories below, you will find references to Citigroup and its CEO, Vikram Pandit. According to Bloomberg, Mr. Pandit wrote the following in an internal memo: “I am most encouraged with the strength of our business so far in 2009,” Pandit wrote in an internal memorandum obtained today by Bloomberg. “We are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007.” Citi surged almost 40% on the story and spurred both short-covering and fresh buying throughout the financial sector. My question for Mr. Pandit is simple: “How do you know — considering the inevitable quarter-end write-downs — whether your bank is truly profitable thus far in 2009?” Investors didn’t wait around for the answers. Even if Citi has somehow managed to eke out a few shekels in Q1, I think the best description of the performance going forward for Mr. Pandit’s bank comes in the form of an imaginary cartoon sent to me by a thoughtful west coast reader. “If I were an editorial cartoonist I would show two kids at a lemonade stand gleaming over having made money today while, to their backs, an out of control semi is careening toward the stand.” Well said; I, too, doubt Citi is truly on the road to recovery.

Chairman Bernanke spoke this morning to the Council on Foreign Relations, and while he made it quite clear the Fed would “will take any necessary and appropriate steps” to ensure U.S. banks continue to function, he also went global with an appeal that other nations take similar steps. “Governments around the world must continue to take forceful and, when appropriate, coordinated actions to restore financial market functioning and the flow of credit,” Bernanke said today. “Until we stabilize the financial system, a sustainable economic recovery will remain out of reach” (source: Bloomberg article below). I have no doubt Mr. Bernanke means what he says, but I question just what “necessary and appropriate steps” will entail. I believe the Fed will eventually be forced to run the printing presses at full speed and will also be forced to monetize a good bit of the assets they take on board. I therefore continue to be comfortable holding some gold and the shares of companies that can profitably mine it.

Snippets of Tim Geithner’s interview with PBS’s Charlie Rose hit the tape late in the trading session, but our Treasury Secretary once again took a pass on providing the details of Mr. Obama’s promised “public-private investment fund”. The full interview will air tonight, and Mr. Geithner made Mr. Rose’s audience the following promise: ““We’re going to move in the next couple weeks to lay out the precise terms of this facility. People will see how it’s going to operate and then it will go into place over the following weeks and months,” Geithner said (source: Bloomberg article below). It’s quite possible Mr. Geithner’s planned fund will deliver on the Obama administration’s promise to “fix” the financial crisis, but we are once again forced to wait and once again forced to wonder just how this program will work. While he has his memo pad open, I hope Mr. Pandit pens one to Mr. Geithner and politely tells him to keep his mouth shut until he’s ready to divulge a level of detail large enough to feed investors hungering for clarity.

Much has been made about the “uptick rule” and how its suspension in 2007 has supposedly hurt our financial markets. Today the SEC announced the rule was under review for possible reinstatement, and I have no doubt that many will view this development — should it some day occur — as a very bullish one for the stock market. Unlike Jim Cramer, however, I don’t truck with those who believe short-selling is the root of all evil in today’s markets. Though I don’t practice the art, I view short-selling as a necessary component of our market system. Less the wicked profiteers they are commonly portrayed to be, short-sellers should be seen more as messengers of bad tidings — not the causes of them. Investors should also remember the added liquidity provided by short-sellers to equity buyers in rising markets and to equity sellers in falling ones.

Rather than recycling the uptick rule, I would prefer that the SEC start enforcing the existing rules designed to prohibit “naked” short-selling (those who go “naked” and sell a company’s stock short without ever lining up the borrowed shares necessary to do so). Some stiff fines for abusers (and their brokers) should do the trick, as well as mandatory “buy ins” for those shorts who thumb their noses at the rules surrounding the borrowing of stock for short-selling purposes. In short…better enforcement of existing rules will help solve the problem and will do so with far less disruption to our markets than simply reinstating the old up-tick rule.

Bloomberg’s first coverage of the Jeremy Grantham article you see at bottom emphasized the bullish aspects of Mr. Grantham’s views. His reasons for doing so were given short shrift The keenest insights in Mr. Grantham’s article have less to do with the fair value of the S&P 500 (which he pegs at 900) and more to do with the process of investing during a bear market. Noting that career risk often governs the decisions institutional investors, he also points out that individual investors become loathe to commit precious cash when prices continue to fall. Both types of investors tend to freeze when facing declines such as the ones generated during the 2007-2009 bear market, and this “rigor mortis” can cause investors of all stripes to miss the eventual recovery. To combat this situation, Mr. Grantham doesn’t tell folks to blindly buy stocks and stop worrying about the market; he instead implores them to draw up — and stick to — a plan of action. I agree and I advise readers to take a closer look at what Mr. Grantham has to say instead of relying upon the “Cliff’s Notes” version written by a journalist.

Wearing his GMO hat on behalf of his investors while managing against others who manage their career risks is no simple proposition for someone like Mr. Grantham. I can’t fault him for saying “buy some” at these levels. As for whether this rally can stick around for more than a day, I can only say that it is quite possible. A sustained up move is even likely if folks somehow become convinced Ben Bernanke, Tim Geithner and the return of the uptick rule will save the day. I harbor less belief that these “solutions” are really just cosmetic in the face of a large and ongoing debt liquidation. Besides, violent rallies like the one we saw today are a hallmark of bear markets. Thus, I agree with Jeremy Grantham when he says “there is still a 50-50 chance of crossing 600 on the S&P 500″. As an individual investor for the time being, I have no career risk to manage. I can be patient and I advise others to do the same before putting all of one’s capital at risk. I’ve recently bought a few names on the way down, and I will have no problem letting them go should the crowd want to pay more for them. Let the risk appetites come back; smart investors will be happy to feed them. —
– Jack McHugh

Stocks Post Best Rally of 2009 on Improving Citigroup Outlook

Pandit Says Citigroup Having Best Quarter Since 2007

Bernanke Urges Rules Overhaul to Stem Risk Build-Ups

Geithner Says Obama Committed to Fixing U.S. Economy

SEC May Weigh Reviving Uptick Rule to Bolster Markets

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