Saturday, March 14, 2009


The market's 10%ish run up last week was sustained by: the nation's three largest banks saying they were profitable during the first two months of the year, General Motors decision not to use the March allotment of bailout funds, and a smaller than expected decrease in retail sales in February compared to January's results. Stocks were ready for a run and they liked what they heard.

Now lets think about those three developments. Banks should be wildly profitable when funding costs are near zero. The issue that remains with us is was the loan loss provision adequate and will they still need new capital that will dilute common shareholders? The answer to the first part of the question is no, while the last portion's answer is yes. Even with boatloads of help from the Fed and Treasury, banks are going to have a rough decade ahead as they learn how to be conservative lenders again and develop a cost structure that fits their diminished earnings capacity. GM said they didn't need the money in March, they publicly said they were not saying that they no longer wanted it available. Until car sales start growing GM will be under pressure and there are no other lenders, since bankers have developed an appropriate understanding of risk, other than the Federal Government. On retail sales, one months result is not a trend. Spending is weak and will stay that way for a long time.

So why did the market's participants get excited? Because it was time and lots of short positions got covered. The good times may extend another 10%. But remember that a 20% run up only gets you back 10% of your losses. The market's decline has been brutal and I feel she isn't done torturing us. She's offering to sell us the Brooklyn Bridge right now and I suggest you take a pass.

Just say no to committing new money and use the market's euphoria to lighten up on positions. Outside of another 10% upward, the probabilities, in my view, are greater that we continue down as opposed to a sustained up trend. 

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