Reflections On The Markets

The S&P 500 rose 6.6% yesterday in reaction to the details of Treasury’s plan, called the Public-Private Investment Program (PPIP), to help banks rid their balance sheets of problem assets. The market had been anxiously awaiting this announcement since Geithner’s February 10 speech, which was glaringly short on details and caused a nearly 5% decline in stocks on that day. From the close of trading on February 9 to the intraday low on March 6, the S&P 500 declined 23%. However, since that March 6 low, the S&P 500 has rallied nearly 24% through yesterday’s close. Where do we stand now? Despite the sharpest rally in many decades over such a short period of time, the S&P 500 is still trading 5% below where it was on February 9, the day before Geithner’s speech.

Let me be clear: I have no idea how successful the plan laid out by Treasury will ultimately be. I do not believe anyone knows at this point. According to today’s Wall Street Journal, “Mr. Geithner is betting that subsidies to buy troubled assets will encourage private investors to bid enough to narrow the gap between what the banks think the assets are worth and what investors are willing to pay.” I am hopeful that Geithner is right, but I see some potential problems. First, it is not clear to me that bids for these troubled loan pools and securities will be high enough to encourage banks to sell in the event that selling would require further hits to capital. And second, it is not clear to me that private investors will be willing to participate in this plan given the Congressional witch hunt that is growing in intensity by the day. Would you invest alongside the government if you knew there was a possibility that the government might change the rules at some point down the road?

So, will the Treasury’s Public-Private Investment Program (PPIP) actually turn out to be the panacea the stock market seems to be suggesting? While we obviously believe the articulation of a plan is a necessary step in the recovery process, we have no idea at this point whether or not this plan will work. Therefore, it is tempting to call yesterday’s sharp rally an overreaction. However, doing so would not consider the fact that the market remains significantly below the level on February 9th, the day before Geithner so disappointed investors by releasing a plan with no details. Compared to the backdrop on February 9, we now have a detailed plan (that may or may not work) to help banks shed problem assets, and we also have some economic data points suggesting an economic bottoming may be within sight. While we would stress that these data points are very limited at this stage, we do believe that yesterday’s Existing Home Sales data, several months of better retail sales, and improvements in certain credit markets are encouraging.

What should investors do? Since March 4, we have been suggesting in these emails blasts that stock valuations, using several different valuations metrics, appear attractive for long term investors. The sharp rally we have seen over the past 2-3 weeks is, we believe, a reflection of this reality combined with a huge amount of cash on the sidelines. We could indeed see further advances in the indices over the next few weeks as fund managers rush to get invested. Our advice continues to be to buy stocks when they are cheap with the intent to hold them for long periods of time and ignore the near-term noise. We are by no means suggesting that we are out of the woods with regard to the worst economic contraction in decades. However, opportunities such as those presented in early March should be seized by investors even if the market winds up testing those lows again.