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There are so many lessons being offered by today's financial markets, yet they're met with so little interest.
After months of watching traders alternately feast on risky assets or vomit them up based on the tonal stylings of every European finance minister's latest utterance, can we now comfortably infer that, even if markets are not innately efficient, they are more efficient than modern democracies and supranational bureaucracies? Sure, we could.
(Just consider the way most investors profess support for national self-determination, open trade and personal freedom, and yet see markets in aggregate agitate for decrees from elite central bankers to print money and buy suspect government debt. Even further, talk to a Wall Street banker or corporate CEO and hear about the U.S. administration's hostility to the private sector and capitalist innovation, then listen for the punch line: "You know who really knows how to run an economy, the Communist Party of China." Don't even get them started on Singapore.)
Or is it that markets, required as they are to "generate content" in the form of price quotes for several hours a day in each world capital, are merely too impatient to wait out the results of the sovereign-debt gut check that they're treated to daily? Exactly.
So maybe it's not nearly so simple as to choose between these two questions and call it wisdom. Market action and governmental-slash-central-banker policy are just too mutually reactive for that. Investors one day might dislike the pace of progress toward a potential European bailout plan, then will pull bids for an Italian government-debt auction, Italian yields will rise, in turn prompting more stern but unsatisfying leaked remarks by the same wouldn't-be bailout artists, who then go about trying to disarm the credit-default-swap market.
As put Friday by Jeff deGraaf, partner at Renaissance Macro Research, "The range of outcomes is so large at this point (bullish and bearish) that confidence levels in predicted outcomes have been reduced. That forces us to play with smaller position sizes…and a more tactically driven outlook."
This pretty well captures the skittishness of even the most disciplined investors and speculators out there. One reason for this stark bifurcation of plausible future outcomes is that both bears and bulls are able to begin their opening statements by declaring, "We've seen this movie before."
The bears can summon visions of 2008, when credit markets were cracking, liquidity evaporating, the stark math of financial-institution stress undeniable even as a relatively blithe equity market clung to assurances that such obvious nastiness was already known and thus "in the market." It didn't matter until it was the only thing that mattered.
The bulls are countering with the quite-logical point that one difference between now and 2008 is that, back in 2008, we didn't have the worst financial crisis in our lifetimes staring at us in our rear-view mirrors at a distance of a mere three years. In this view, the '08 experience serves as inoculation, not the pattern for a fresh contagion.
So, the market, we're told, rolled over Thursday on a warning by the third-place credit-rating agency that further sovereign-debt distress would not spare U.S. banks, coupled with ugly televised riots by Greek citizens upset with austerity measures? Maybe that's the way it happened, at least for that day.
Or was it that the pressure of the recent nervous trading range finally caused the Standard & Poor's 500 to fall beneath an overly popular "technical level" of 1225, after which it hit a big air pocket to drop another 10 points before they rang the bell? How's that for a lesson: When your "stop-loss" order matches that of so many others, it becomes a "start-loss" order.
It is not wrong to be concerned about possible hellish contagion being loosed by the euro crisis; it is, in fact, irresponsible not to worry about it. When this is the proximate cause of some of the jumpiest, most mono-directional daily market action in history, it's the thing to argue over before getting to all the others. U.S. stocks right now have never been more correlated on a day-by-day basis to such global risk-appetite gauges as the Australian dollar.
Yet when was the last time the history of a bear market began with a recounting of a credit-agency report, Greeks unhappy with their politicians and the breach of a widely endorsed technical trading level?
Tim Hayes, strategist at Ned Davis Research, late last week took note of the market's literally unprecedented one-way daily thrusts and concedes that "the global stock-market recovery is less decisive than it was a month ago," when NDR switched to an overweight position in equities.
Still, he goes on to say that "continuing evidence of economic resilience" (which was much in evidence last week in the housing, retail, unemployment-claims and leading-indicators data) should confirm the stock market's refusal (so far) to buckle all together.
"Right now, the sentiment and valuation indicators are nothing to worry about," Hayes says. "And investor worry is a positive condition. The market says it wants to go higher." If only it were so easy for most investors to be as confident as Hayes is in deciphering the market's statement of intentions, we could all permit ourselves to worry less and draw some soothing lessons from this trying year.
WHEN A CORPORATE BOARD hires Goldman Sachs bankers to undertake that lucrative euphemism of "exploring strategic options," and after three months the board endorses Goldman's counsel by pursuing no alternative to the current strategy, how should shareholders be expected to react?
Well, this just happened in the case of the discount broker and mortgage banker E*Trade Financial (ticker: ETFC), and the result has been a fast bleed in its shares. The strategic review was undertaken at the demand of director Ken Griffin, founder of lead investor Citadel. Griffin on July 20 informed the company's board of the review, and the shares subsequently rose from below $13 to above $16 as the market took the logical leap that E*Trade was being put up for sale, further consolidating an industry with precious few players of great scale.
By the time the company tersely noted on Nov. 10 that the review would result in more status quo, the shares were already below $10, thanks to general weakness in financial shares and growing concern about the lack of deal news. Since then, they've sunk to $8.23—cut in half year to date, at 79% of tangible book value. For some perspective, the stock traded below a split-adjusted $8 only during 10 days surrounding the March 9, 2009, stock-market low.
The market's inference, clearly, is that if Goldman couldn't find a buyer, there isn't much here worth buying. But this is likely a short-sighted conclusion.
The assumed hang-ups to any potential acquisition of E*Trade are management's willingness to sell at a depressed valuation and the abiding dead weight of E*Trade's bank unit. It hasn't made a loan or bought one since mid-2007, but before that it had gorged on plenty of odorous housing-bubble flotsam that required Citadel to make a rescue injection of capital. The loan portfolio, while unattractive, has stabilized in its performance, and E*Trade has joined other banks in releasing reserves since the crisis abated.
An acquisition of E*Trade would require an accounting treatment that would essentially wipe out the bank unit's regulatory capital, so any deal needs to include an effective recapitalization of the bank. Messy and confusing, but doable. Some buyside investors suggest, making fair assumptions about those capital demands, that a strategic investor such as TD Ameritrade (AMTD) could cover this outlay and still pay $15 or more a share for E*Trade while having the deal be accretive to the buyer's earnings.
Such a scenario seems less imminent, but no less plausible than it did a few months ago. E*Trade still has 2.8 million brokerage accounts and $176 billion of customer assets, which remain valuable to the point of irreplaceable in a growth-starved industry. A policy of waiting means the loans continue to "season" and roll off the books, while the core business essentially sits there, not thriving amid retail-investor disengagement and near-zero interest rates, but faring no worse than peers'. The company has been profitable each quarter this year and is projected to earn 67 cents a share for 2011.
Sandler O'Neill analyst Richard Repetto a week ago gently called E*Trade's announcement of its decision to stay the course "a missed opportunity to boost investor confidence through transparency." Yet he added that the Goldman-led review by his lights involved no formal approaches to possible buyers, so it might not be a case of acquirers sniffing around and being repelled by the smell.
Repetto further points out that the implied "option" inside a share of E*Trade does not decay in value as a traded option does, but appreciates as loans roll off, repairing the bank's capital position internally and moving the company incrementally back toward being a pure discount broker. He's sticking by a share-price target of $16.
E-mail: michael.santoli@barrons.com
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