Page 2 of 2 Clippers kept happy By Julian Delasantellis
even chancing any more falling big dominoes. With a general perception that
companies are going to be kept breathing at all costs, even if it has to be a
"Weekend at Bernie's" type operation that makes a dead financial carcass look
alive, the main threat to bonds' secondary market value, default, is
eliminated. Buy them bonds, clip those coupons.
And stocks? Well, here, the markets seem to be saying that keeping bonds on
life support may be possible, but the prospect of the government breathing the
breath of life into stocks, producing higher earnings, is not yet in the
picture. Maybe now that the financial system has been saved, the Obama and
Chinese economic stimulus programs will be able to blow some earnings back into
stocks' coffers in the near future, but as long
as the financial system is valuing bonds over dividend paying stocks, the
system is still flashing yellow and challenging government to "show me".
Another attribute of the financial system rescues is also contributing to this
phenomenon. Bondholders and stockholders may essentially be brothers, or at
least cousins, in the family of financial products, but these days, a lot more
preference and partiality is being shown in favor of one brother over another.
Both Paulson and Geithner have gone out of their way to shield financial-system
bondholders from the howling vicissitudes of the current financial crisis; fund
manager John Hussman suggests that the total taxpayer tab for these bondholder
security blankets could be in the vicinity of US$10 trillion to $14 trillion.
The defenders of this practice will argue that protecting the bondholders over
the stockholders, who have customarily been losing 100% of their equity stakes
in these rescues, is beneficial since bondholders were given an explicit
promise of payback by the companies. That, of course, is the nature of bond
investing, but it still does not vitiate the fact that many of these bond
investors are a class of speculators known as "vulture investors"; these
deliberately invest in cheap, discounted bonds of companies they know are on
the ropes in the hopes that someone, be it another company with some manner of
government backing, or maybe the government itself, will rescue the company,
along with their bonds, allowing them to sell out their positions for a healthy
profit back up near or at par.
If you believe that there is a 100% probability of government rescue, why not
have some fun and jump into the deep end of the pool without a life jacket?
Like a woman's fashion cliche that rushes to tell you that glaucous is the new
rhodopsin, or zinnober the new vitellary, if bonds are the new stocks, what are
stocks? Would you believe that stocks, especially financial stocks, are the new
call options?
Late last February and early March, before stocks bottomed early on March 9,
was a truly historic time in the markets. As pundits and bloggers egged on the
Obama administration to nationalize the financial system, or at least its major
components, a once-in-a-lifetime sale was held on some of the most historic
names in world finance.
Bank of America traded down to $2.53 a share. Citigroup dove to under a buck,
GE down to $5.72, American Express hit $9.71, Wells Fargo, under $8. Many
observers, prominent among them Karen Finerman of CNBC'S Fast Money,
considered buying these storied names at these levels as less like buying a
stock and more like buying a call option; if the companies failed and the
government declined to rescue them you, like the rest of the financial stock
investors felled by the crisis, would most likely lose 100% of your investment,
as is very common in long option purchases. If the government could convince
the markets that it stood ready and willing, to prove that these big
institutions were, indeed, too big to fail, big, option-like profits could and
would be had in these names.
We now know that the US government had no intention of either nationalizing nor
seeing these names go under. From $2.53, Bank of America traded up to $17.6,
Citigroup went from 99 cents to $5. GE from $5.72 to $15, American Express from
$9.71 to $34, Wells Fargo from under $8 to $29.35.
Volatile moves like this are very common in option trading, where they are to
be expected, but they are still fairly uncommon for highly capitalized
equities. Perhaps investors should come to expect volatility like this,
especially since, if the world's economic managers suddenly decide to harken
back to pure free-market principles, pulling out from under the "too big to
fail" implied guarantee that put a floor beneath these stocks in the spring,
these rapid risers will astound once again, with their even more rapid declines
back to, and perhaps beyond, the late-winter lows.
From the 1960s, after the 1956 Soviet invasion, to the fall of communism in
1989, Hungarian economic policy was generally referred to by the moniker
"goulash communism", referring to a relaxation of Soviet-style central economic
dominance in favor of a mixed economy that featured state control at the top
and good levels of market based economic freedom down at a more amply supplied
(at least as compared with the rest of the Soviet bloc) consumer level at the
bottom. Measures along these lines were also attempted in Czechoslovakia from
the early 1960s to that country's Soviet invasion in 1968.
As a result of the financial crisis, something similar has happened in the
United States and other major capitalist economies. Markets down at the
consumer level are still as free and unencumbered by government influence as
they ever were; no matter what Obama's health apparatchiks might desire,
there's still enough cookies and sweet treats in any American supermarket to
give a whole American school system diabetes.
But up at the levels of what communist reformers used to call the "commanding
heights" of the economy, a new, public/private hybrid governing arrangement is
settling in. Will the government voluntarily pull back once, or maybe if, a
recovery gains apace, or will the issue be decided in the streets, as, to a
certain extent, the issue of healthcare is being decided in the United States
now?
Market players, very much unlike pundits, put money behind their opinions.
That's what's going on now with the delicate re-arrangement of the roles of
bonds and stocks. In the great symphony of human commerce, government has taken
the bandleader's baton from the markets, and for the two-step now being played,
bonds have taken the lead.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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