Don't Be Fooled

Most of us are raised to trust in the environment we are born into. Our reality is what we are taught and experience. Occasionally, there are times when our perception of things do not reflect reality. We see little signs that seem odd but our trusting nature dismisses them and we continue on our merry way. Reality being what it is has a way of asserting itself. Our false perception is eventually destroyed and we are forced to see things as they truly are, not as what we would like them to be, and expect them to be if the world operated in an honest transparent way. The real world is not entirely composed of trustworthy individuals. It can be dog eat dog. Take care of number one and the rest be damned. The investment industry is a representation of this. A large proportion of individuals mean well and act in a way that they believe is proper and sound. They are trusting and well meaning. But the industry as a whole is geared to serve self interest first and the investing public second. The perception that putting our hard earned money into investments which will reap rewards over the long term is ingrained into us. Currently that perception is being challenged. Investments are turning sour, even in the long term. Yet the majority of people see this as an oddity, a temporary blip that will quickly correct itself. This is not a time to be a passive trusting believer. The oddities of the markets right now are not to be dismissed. Reality is asserting itself.

There is a little reported story about the CEO of the Bank of America, Ken Lewis, who testified that in the cauldron of the financial meltdown last fall, he was threatened to buy Merrill Lynch before it’s imminent collapse. The alleged men behind the strong armed request was the tag team of Paulson and Bernanke. This intervention of the Treasury and the Federal Reserve into the business decisions of a private corporation speaks to the level of desperation and collusion that took place behind the scenes. Lewis caved in, betrayed his responsibility to the shareholders, purchased Merrill Lynch in haste, which has since proved to be a terrible investment that has destroyed shareholder value. This was potentially criminal, and most certainly inappropriate. The District Attorney of New York is investigating. Bernanke has denied the allegation. Someone is lying. Strangely, Lewis is still supported by the shareholders even after this story became public. Perhaps they are afraid to put an honest guy in control and have him uncover the corruption within. Self preservation is a powerful motivator. Criminal behaviour was blatant throughout the sub-prime mortgage fiasco, yet all the parties involved looked the other way. Money was being made. Now there are numerous criminal investigations underway that involve the misuse of the bailout funds. The continued greed and abuse of power is astonishing. Revelations such as these reveal how politicians and CEOs are perpetuating fraud. The public’s anger is simmering. There is a sense that no one can be trusted. This is an age of information management and spin. The lies, deceit, and the dirty under belly of big business and government should not be viewed not as an oddity.

Chrysler has filed for bankruptcy. This should be devastating news as the effect on the economy will be felt, especially if it foreshadows the same fate of General Motors. The stock market didn’t even blink. In the face of the Treasury fumbling around with the results of their stress tests of the largest US banks, which must surely be bad, the stock market rallies. The headlines read the banks are profitable again. This is crazy. How can that be? Less than a year ago they were on the verge of collapse. Yet the market rallies. When stocks continue to rally on bad news, one has to question the logic of this. It can be argued the smart money is looking forward to an anticipated recovery and they view this time as a great buying opportunity. This is the Warren Buffet school of thought that is always trotted out to calm the fears of the investing public. The stock market is forward looking we are told. Rubbish. Last summer it was at an all time high. That cheery outlook was obviously misguided. But perhaps there is some validity to this tired old slogan. It suggests that there is some irrationality in the markets that has depressed it to these extreme lows and it is bound to go higher once this fear has abated. I would suggest that watching the banks of the world literally hanging in the balance, receiving billions of life support money just to keep the doors open; anticipating General Motors and Chrysler going into bankruptcy and all the ripples that will flow from that event; watching AIG, one of the largest insurance companies resemble a black hole of taxpayer money; and watching as China and Russia reveal their desire to dethrone the US dollar as the world’s reserve currency all to be very troubling. Escalating unemployment, mortgage defaults, lost savings, and drooping consumer spending all portend a bleak future. It’s a very rational decision not to own stocks, or bonds for that matter. There is little positive data to support the latest rally. Indeed, the current optimism is nothing more than wishful thinking as the fundamentals remain extremely weak. So who are these smart buyers who are so prescient to see what others cannot see? In the past month, one fifth of all stock trades on the NYSE was done by Goldman Sachs for their own account. There is a whiff of market manipulation here. This sounds conspiratorial, but the fact is that central banks and governments are already operating openly in other asset classes to prop up the market. Rumours of a covert Plunge Protection Team are rampant in the investment world. The financial system is built upon rosy assumptions of continued gains in the stock market. The motivation to make the equity market appear as though the worst is behind us is clear. If the economy is believed to be truly on a precipice, then it’s reasonable to suggest that a manufactured market rally is in the works. The rules of the free market no longer apply. The bailouts bought time. Time is running out again. The latest rally is an oddity that should not be ignored.

The reality is that the bad debts that are crippling the world economies need to be either paid off or defaulted. There are no other solutions. Right now everyone is trying their mightiest to delay the inevitable. Private corporate debts are being pushed out to the national level. Wealth isn’t being created. It’s getting redistributed. The well connected are getting their bad loans paid off thanks to this grand effort to save the system. Those who risk their capital need to face the consequences of their bad bets, otherwise the market is uneven. The constant tampering of the markets, in an attempt to instill confidence, actually undermines confidence because the rules keep changing. The game is rigged. The ‘too big to fail’ players will win. The well connected will win. The political heavy weights will win. Rational active investors are pulling out of the markets and sitting on the sidelines because the markets have become irrational. The remaining players are playing the market.

This game is too large for any one player to manipulate and control in the long run. The market has a momentum all of it’s own. The central banks can control the size of the money supply but they can’t control how individuals use it. They are losing control. The tail is trying to wag the dog. This fight will ultimately be fought between the big players and it won’t be pretty. Watching how the Chrysler bankruptcy unfolds will be a prelude to the larger battles that will ensue in the future. Obama and his team tried to extort the holdout creditors. Hedge funds are the scapegoat of the day. Diplomacy and fair play should be the playbook. It doesn’t appear that it is. Politicians will exert their powers. China will not politely take the default on their investments and they will do whatever is necessary to receive payment before that happens. The unions will not lay down their arms or promised pensions and benefits without a fight. Selfish corporate interests will grab what they can anyway possible. And the angry populist mob will be heard. Crime, threats, and unseemly undercover deal making will be ongoing as everyone will grab what little they can before there is nothing left behind but scraps. The small investors with money in retirement plans are irrelevant in the eyes of these players. A rational decision when confronted with a pack of desperate hungry dogs snarling at each other over a carcass is to back away because you are dog meat in their eyes.