• February 27th 2009 

Seeing both sides

In this months newsletter I wanted to divert from the personal finance topics to layout arguments for what could change the negative market momentum. I am not trying to naively paint a positive picture, but to start a dialogue. It is important to always see both sides.

One could say the path of least resistance is down in the market. While I have to be realistic and say that could be the case there is also a counter argument that says we could move up, at least for awhile. So lets take a look at both sides:

The easy argument:

Momentum is on the downside, news is horrid and the economy is a wreck. That is basically what we are hearing everyday from the media and it is easy to jump on that bandwagon.

The counter arguments:

1. We have just registered weekly and monthly exhaustion levels with the S&P on a widely followed technical indicator. This usually precludes a 1 to 4 month counter trend rally. Note: although the indicator means the month of March should close higher than February, it doesn't mean that we can't take a stab lower prior to recovering later in March (think V shaped bottom)

2. Mark to Market account change: The current accounting rule requires companies to mark their assets at current market prices, which is why we have so many problems with highly leveraged institutions. Let's look at it this way:

Balance Sheet:

Assets = Liabilities + Shareholder Equity

So if you are a Bank and have a whole bunch of securitized mortgages or credit card debt sitting on your books that was once trading at 100 cents on the dollar and now is trading at 30 cents on the dollar, your assets have shrunk dramatically. So to equal out the equation above, if your liabilities haven't changed then the only thing that could drop to reflect the lower assets is your shareholder equity (stock price). So far the governments band-aid approach of buying stock in banks hasn't helped. What could you ask? A mark to market accounting rule change.

GE, GM, Citibank, American Express, you name them and they have massive amounts of securitized debt on their balance sheets. The holes in the dike are popping to fast for the governement to plug them one by one. So what if they temporarily suspended the mark to market account rule? Maybe a rolling 3 year average of the price of the securitized debt. This would give companies a chance to solve the problem on their own without taxpayer dollars over a longer period. Because right now the way accounting rules work, it doesn't matter if the company is making enough cashflow from operations to hire folks and keep moving forward. If their Balance sheet is dropping they have to declare losses and can become technically insolvent quickly. So if this rule changed, we would see a dramatic market shift overnight. By some measures possibly 20% gains in the market.

3. CDS backstop: I won't go into this to much but just to say that Credit Default Swaps are a derivative with nightmare proportions. AIG underwrote these in mass quantities never assuming there models would go bust. If the government were to step in and backstop them or eliminate them from speculative plays then we could see a big surge just like with the mark to market change.

These may be long shot ideas, but it is obvious that the approaches that the goverment has used thusfar with our tax dollars haven't worked. I may be overly optimistic that our politicians are intelligent enough to make these bold steps, but the possibility must be considered. (I continue to hear rumors about these items happening, but so far nothing.)

Well there are the arguments on the positive side. I would be curious to hear your thoughts. Feel free to email me.

James A. Daniel,

This newsletter if for informational purposes only. The information contained within should not be considered as financial advice nor soliciation for financial services. Consult with your financial professional if you have any questions.

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