Wednesday, May 20, 2009

The New American Bull

Mmmmmm, you can taste the excitement in the air. The euphoria. The bottom is in, we hear, and the worst is finally behind us.

In early March, as the DOW was touching down around 6500, the daily sentiment index reported that the percentage of traders that were bullish was under 2%. This past week, as the stock market roared past 8500, the percentage of traders that were bullish clocked in at just over 85%.

So what happened over the past few months to cause this 180 degree change in investor attitude?

Stocks Rose In Price

This, and only this, was the determinant factor in investor psychology. Investors move in herds, and watching them move and reason together is fascinating.

What really happened is that stocks became much, much more expensive. The second event occurring simultaneously over the past few months was the fundamental structure of our economy worsening significantly.

The following is a chart showing the earnings of the 500 largest American companies, known as the S and P 500:



As you can see the earnings have disintegrated. In fact, they are down over 30% this year alone.

This means that as stocks have risen by over 30% (become more expensive), the earnings of these companies have fallen by 30%. This is not the formula for long term growth, and all indicators show this trend continuing. (Both the herd of investors entering the market, and the fundamentals of the economy deteriorating)

The stress tests for our largest banks has been a marvel unto itself. I have to admit, the government has played this hand extremely well. The phony tests provided a "worst case scenario" for the amount of capital these banks will need. This has allowed them to enter the market and raise private capital by selling new stock.

Bank of America just last night sold $13 billion worth of stock. This will allow the government a few months of breathing room before they have to come back in and provide these banks with additional money. Every investor purchasing these stocks now to hold will ultimately be annihilated.

This will give the government time to focus on destroying other aspects of our economy, such as the auto industry. With their quasi nationalization of our bankrupt and unprofitable auto business models, they have ensured that these companies will never become profitably and will never be capable of generating new capital in the free market.

They can also focus on two more additional storms fast approaching.

The first is the fact that states across the country beginning to go bankrupt. The incoming tax revenue is falling and in some cases disappearing due the economic collapse. These states will need bailouts.

The second is the major pension funds who are in serious trouble. Many of these funds changed their investment allocation over the past few years from the safety of government bonds to mortgages and stocks to try and receive a higher return. Most of the pensions entered these markets right as they collapsed. Because they do not have to report every month, this is a dirty little secret awaiting many retirees.

These two storms combined with the commercial real estate and credit card crisis should keep the government busy until the major banks start to collapse once again. Until then, enjoy the show, it'll be interesting to see how long the trillions of printed dollars can keep our bubble economy artificially afloat.

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