Even the Grinch Got Used to Pantookas and Wuzzles

Ramblings of a Portfolio Manager or Even the Grinch Got Used to Pantookas and Wuzzles

What a week in the equity markets. The market took the triple onslaughts of Chinese monetary policy tightening, Scott Brown’s upsetting (to Democrats) victory, which produced the opposite of the expected effect by spurring Obama’s attempted face-saving attack in the form of plans to dismantle our world-leading financial system and a slew of rats, er Congressmen fleeing the sinking ship of State by backing away from the President by rejecting his preference for the reappointment of Federal Reserve Chairman, Ben Bernanke. As for the later case, when rats flee a sinking ship it is to save their own skins and they typically jump overboard rather than chewing a hole in the hull, hastening the demise of the doomed vessel. But Congressman, like rats it seems, cant read or understand spoken English and our boys on the hill are chewing big holes by ignoring the effect their defection from support of Bernanke would have on our already weakened economy and financial system and, by derivative, the equity markets. But at least they can comfort constituents on Main Street with “I didn’t support that guy who single-handedly brought down our financial system…Oh, so sorry your 401(k) is down 20% as a result.” At least our rats have their own safety net for the capsizing they will cause. Too bad for their constituents. Anyhow, the result of the Trifecta of bad news was the worst three day period in the markets since last February, a time when it wasn’t clear whether or not the Country was going into another great depression. The S&P 500 ended down 3.9% on the week and is now down 2.02% for the month while the Dow dropped 5.2% (552 points), ending down 2.45% for the year, and the Russell 2000 lost 4.53% ending down 1.29% for the year. Thanks, fellas, for working hard for the unemployed and looking out for the savings of the still employed.

Reality check. Is there reason to be concerned over the news and results last week? Is this the long-expected market correction? Our answer is no and no. First of all, everything that happened last week was the result of ever lurking but always surprising headline risk. Occasionally, politicians will say or do something dumb (maybe more than occasionally lately) and the markets extrapolate that information into a virtually certainty and immediately discount the expected results. That’s what markets do, but it doesn’t mean they are always accurate in their predictive power. In any market there is what is called “noise,” which is information that is market moving but non-impactful to underlying long-term fundamentals, and there are long-term policy or structural economic shifts, which are. We put last week solidly into the noise category.

Noise #1, China: funny how all the cynics who claim China is falsely inflating their economic numbers jumped on board with “told you so” when the Central Government tapped on the economic brakes last week. Let’s get this straight—the Chinese are purposely faking monetary contraction to lend credence to their faked economic expansion? Uh huh. Believe it or not, many of the Chinese Central Bankers were educated in Western Capitalist running dog business schools, studying past Fed actions, and understand the value of signaling. That is, it’s not so important what the “Fed” does as what it says in accomplishing its goals. We believe last week’s news release that the Chinese told banks to stop lending for the rest of month was more signaling than fact but, in any case, let’s put it in perspective—will two weeks (that’s all it is—not a permanent change) of reduced credit really derail the expansion of the worlds’ largest population? We don’t think so. Remember, our thesis is that the Central Government has 1.3 billion angry peasants to please. Putting the economy into decline is not going to cause them to put down their pitch forks and torches.

Noise #2, Banking reform: Even Geithner and Frank were surprised by the President’s announcement and subsequently tried to tone it down. In the former case, Turbo Tax Tim may be shown the door but Barney Frank is notoriously difficult to remove. Even that radical Congressman publicly declared the proposal too drastic and sought for a 3-5 year transition period, if the bill ever passes. We think the whole proposal dies an ignominious death either when we get a goodly portion of the democrats out of our Congress in November.or even earlier, when the incumbents get smart enough to realize that a consistent message of scapegoating does nothing for getting their constituents jobs and them votes.

Noise #3, Bernanke. This is a little more disturbing than the previous two as it is based on the unpredicability of panicky politicians. As Warren Buffet said, “let me know if Bernanke isn’t going to get reappointed so I can sell stocks.” We agree with him wholeheartedly. Blaming the prior administration for the current ills is a favorite tactic on Capital Hill and Bernanke is the scapegoat du jour, especially among Senators wishing to distance themselves from the flailing President. In point of fact, even if he is not reconfirmed, Bernanke will still sit on and control the FOMC, which sets rate policy decisions, so we will still have his wisdom and education to guide rate policy, but a weakened Fed is one without great credibility on Wall Street, which is not good. We believe that, ultimately, sanity will prevail and Bernanke will be reappointed (or for no other reason than they don’t have a viable alternative), but it will prove to be a volatile week ahead as rumors, sound bites and polls pollute the airways.

Bottom line: We think the 5% correction we just had is healthy and about as much to expect from the latest round of headlines. Volatility may remain elevated for a time but, ultimately, the markets will continue to grind higher as pending Congressional gridlock draws nearer and companies continue to report stronger than expected earnings.