After a strong showing on Monday, the markets pulled back aggressively yesterday as folks were largely disappointed by the Treasury Department’s plans for helping the banking system. It was a clear case of buy the rumor, sell the news.
We continue to believe that an RTC type bad bank structure could be an effective solution. The new secretary Tim Geithner seems to agree, but may be intentionally vague on the details of a plan to “stress test” the system into pricing bad loans on their own. Unfortunately, it is true that banks are unlikely to sell bad assets if they think the government will pay up for them, but with the political pressure of the public rightly focused on taxpayer liability, the only thing that may force the issue is if the market pressures continue, forcing the weakest players to fold. This is, of course, a dangerous mix, but one with perhaps no viable alternative given the environment. If things are that bad, someone must cry uncle. The past fourteen months have been like a giant game of hot potato. Unrecognized losses are being tossed around in musical chair type fashion, waiting for someone to own up to them, or for the mother of all players, the U.S. government, to socialize them.
The good news is that the credit markets have been operating much better than they were back in September when the fall of companies like Lehman Brothers threatened to bring down the entire money market system and the commercial paper markets were in shambles. (A reason the Treasury Department must be careful with their “stress” testing.) On Monday, Cisco Systems managed to raise $4 billion in debt at a yield of roughly 5%, suggesting that those who are credit worthy can raise just about whatever capital they’d like. With nearly $30 billion in cash on their balance sheet, Cisco could enter the banking business itself if it so chose.
On an unrelated note, there was also an interesting article in yesterday’s journal which highlighted China’s efforts to stimulate the demand of its own consumers to make up for the lack of demand from places like the United States. An emerging Chinese consumer is indeed the next logical progression in that country’s arrival as a developed country, but the journey is likely to be a long one. It bears keeping an eye on.
One final comment. Over the past few days since Walt Disney reported earnings, there has been a great deal of talk about weakness in the advertising markets, not just within newspapers, but television as well. To a large extent, advertising has always been a hugely cyclical industry, but there is no doubt that strong secular changes may be at work as well. Tough times almost always cause an acceleration in changed behavior if for no other reason than that it is necessary and to do otherwise would be too painful. (Crying uncle, hot potato and musical chairs…yada yada yada.)
With some of the younger generation canceling their cable television service and finding their video programming online, there can be no doubting the fact that the current weakness, though predominantly cyclical, also has secular undertones. Creative content will always be rewarded in the marketplace, but how it is delivered and the cost of such delivery will certainly change. We’ll be certain to keep that in mind as we manage our investment portfolios for the years ahead.
