Turning a Blind Eye

By Jerry Slusiewicz | July 22, 2008 | 4:15 PM | 0 Comments

What's $6 Billion among friends?  Apparently not much as Wachovia Corp. (NYSE: WB) and many other banks continue to announce staggering write downs due to mortgage losses.  Recently, Bank of America (NYSE: BAC) had excellent news when they announced their earnings had dropped 42% or $3.4 billion from the prior year!  Their stock is up 57% in the last five days - not a bad return given that in addition to less profit they had to increase their net charge off and nonperforming asset expenses to $5.8 billion. 

I am obviously stating this tongue in cheek, but it is one of Wall Street's favorite games to talk down earnings so much in advance of the actual announcement, that a stock rallies in the face of bad news.  The reality is that banks are not out of the woods yet.  It has been four quarters in a row of mortgage meltdown mode.  And it is not contained to just the subprime market.  Alt -A and prime loans are now having difficulties as well.  The problem will continue to spread until the housing market finds a bottom.  It is that simple. Turning a blind eye to this reality may be good for traders and those covering their naked short positions, but as far as long term value seekers are concerned, these snap back moves do not signal new buying opportunities - yet. 

A quick lesson on how the market works is in order.  Many believe the market works off of information in the real world (like announced earnings).  It does not.  Analysts from around the world form a consensus of expectations of the future and move the price of a stock to that perceived value.  When earnings are finally announced (Reality) the market moves plus or minus depending on the difference from the previous perception.   So there's three parts: Perception, Reality, and the Difference between those two. 

Now the journalists and pundits get caught up in this all the time and headlines extol the virtues of huge write offs and major declines in earnings as good news, because it's not as bad as perceived.  That's great for a trade, but direction counts!  The current direction for financials and the major markets is still down.  While things may not be as bad as perceived two weeks ago - the reality is things are not so great either. 

The two major problems in today's economy that are adversely affecting the markets are the high price of oil and the falling value of real estate. While I have said much in the past about how I think oil is due for a correction down in price, the peak of resets on adjustable rate mortgages does not occur until October of this year.  Until we at least get through that - the buildup of unsold inventory of houses for sale will continue to grow and home values will drop. 

The good news for investors in the stock market is that it looks ahead six months to year.  Eventually the economy will get stronger, and the market will discount that in advance.  I think this recent rally in the market has more to do with overcoming the oversold condition we were in and not the start of a new bull run.