E-piphany

Get out those Dow 10,000 hats again! (Mine is getting a little worn-out).

At the bell, the Dow was actually sitting below 10,000, for the first time in several months. After the normal end-of-day monkey business, the index officially printed a close of approximately10,002, but they ain’t fooling anybody with that. This was an old-fashioned beat-down, with the S&P ending down 3.1% and 10y Note futures up 21 ticks (plus another four by the close of the stock market).

There were a lot of reasons given for the sloppy trade lower, but before mentioning them I should remind readers that big moves – especially downward – do not necessarily have to have a clearly-defined cause. Real-time surveys taken during the day of the 1987 Crash (part of an ongoing research project by Robert Shiller, covered in the original version of Irrational Exuberance) found scant mention of any of the “causes” later assigned to explain the Crash. Sometimes, bad things just happen, and sometimes it just takes a little push to set off a chain reaction. (Worth reading in this regard, by the way, is a book called Ubiquity: Why Catastrophes Happen by Mark Buchanan.)

Global markets had come into the day weak, as recent attempts by the EU to sweep the Greece issues under the rug for now served only to agitate investors into asking “what other problems are too big to sweep under the rug?” In particular, questions continue to be raised about the other PIIGS, in particular (today) Spain. For reasons I have never understood, the question of Spanish banks’ exposure to the property bubble – which was just as pronounced in Spain – never seemed to concern anyone during the 2008 crisis. Suddenly, people are concerned.

A friend drew my attention to another story that brought jitters to the municipal bond market completely unrelated, of course, to Euro issues. The City of Harrisburg, Pennsylvania is reportedly considering bankruptcy as a “budget option” (story is here). The city apparently is out over its skis because it built a big incinerator and debt service on it is more than the property taxes in the entire city. It isn’t clear how the city ever expected to pay for the incinerator, unless they planned to do it out of “projections” of future property, sales, and income tax receipts somehow. It is a good reminder that it wasn’t only the big banks and “prop traders” who caused the financial/economic crisis: all sorts of entities were budgeting on the basis of perpetually rising property values and an extensive period of prosperity. But the concept of “municipal jingle mail” where a municipality declares bankruptcy simply because it is expedient to do so as a “budget option” is something that seems new, different, and threatening.

Add to this the surprise in Initial Claims, which I doubt would have concerned anyone by itself. The surprise, as Claims rose to 480k instead of falling as expected, was reinforced by the fact that the upward surprise last week turned out not to have anything to do with California’s filing backlog after all. California actually reported a decline in claims last week, rather than a rise. That suggests some risk that the bounce in Claims is, in fact, sorta real. The day before the Employment Report, no one wants to hear that.

The expectations for the Employment Report are for flat Payrolls (Consensus: 0 according to Bloomberg, with an expected rise in the Unemployment Rate to 10.1%), but I daresay that prior to today there was significant hope for a cheery, positive number. That was prior to the Initial Claims report, which probably shouldn’t matter much but does, psychologically, and a statement from the White House that the benchmark revisions to last year’s numbers might be more negative than the -800,000 being talked about (would that imply the Administration added even more jobs than they said? The mathematics of hypothetical job creation confuses me). Again, that shouldn’t matter for today’s trading, since it’s last year’s data, but it does.

And there is still another fundamental reason to be wary of Payrolls, although since the report is for January Payrolls anything can happen (as a counter-weight to the observation I am about to make I will note that Deutsche Bank, which has been characteristically upbeat on the economy recently, suggested that the number could be a high-side surprise since fewer retail workers were hired in January, and therefore fewer will be laid off than the seasonals expect).

Last month, I wrote about the fact that Nonfarm Payrolls have been running drastically ahead of ADP, and that the Street forecasts implied an even-greater divergence (which seemed unlikely). There was a downside surprise – but the divergence actually still grew (see Chart below).

ADP Still Needing To Catch Up?

The consensus Jobs forecast of 0 implies that NFP will be stronger than ADP once again, and this spread would actually widen to 622k over the last year. With again the caveat that January jobs are even more difficult to forecast than normal, I would still say the risks are for a downside surprise. (And for another caveat: after today’s trade, the potential reaction value to a mild surprise is much lower so if I were trading it, and I’m not, I’d probably sell a pop in the bond market that happened on a weaker-than-expected number on the theory that the quarterly refunding is coming very soon and there would be lots of sellers with me).

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As we look forward to tomorrow, perhaps (if you are an equity investor) with some trepidation, it is worth recognizing that equities are overvalued against cyclical earnings and overvalued when looked at from the perspective of the Q ratio, and over-owned as well. Let me introduce a final poignant anecdote.

It is amazing how many of my friends and colleagues in the financial markets have told me about the great year their companies had, and they personally had (at least, until the government started levying additional taxes on bonuses), in 2009. Of course, the great year in 2009 came about only because of the disastrous 2008, which set the stage (through cheapening some risk assets unduly, widening spreads, etcetera) for 2009. But at the end of 2008, no one was asking or expecting the year they actually had in 2009. All they wanted last year was to not repeat a year like 2008.

But now, in the afterglow of 2009, most people I speak to talk about “maintaining positive momentum” into 2010. The most-realistic of them don’t expect a repeat of 2009, but desire, and expect to some degree, a good year nonetheless.

I think it is striking that this seems to be a near-uniform view. I always admonish my friends by saying something like “I’ll bet you would give away 2009 if you could also give away 2008.” The truth is, neither year was the norm. 2006 or 2007 is what you might get, or 2003.

It actually is interesting that my friends always agree they would trade 2009 away, paired with 2008. If what the Administration and media says about us (traders) is true, we collect all the upside and get none of the downside. If that is the case, then 2008+2009 should be a clear gain: 2008 was a zero, but 2009 a great year. But that isn’t at all how people feel about it. I suppose the most mercenary of Wall Streeters may think this way, but that person was likely the first person flushed in 2008. Most of the folks who remain, most of the people who consider finance a profession rather than a game, were damaged by 2008 far more than merely in their bonus.

But Wall Street expects a year closer to 2009 than to 2008 – anyone who read the annual Barron’s Roundtable articles can see that. It is unfortunate. Those who struggle too hard may well be hurt in the struggle. They should remember the lessons learned so dearly in 2008 – which may or may not be the right lessons but are worth keeping in mind in 2010. And one of those is summarized very succinctly in this song, which I assume is about the stock market (and perhaps directed at CNBC).