The Stock Market--What To Watch Out For

Uncle Bill is always looking out for your well being and as the credit crunch heads west and out of sight, I think, there are some real things to worry about and they are---

1) politicians

2) the Supreme Court

3) the Fed

As the guys over at MarketMinder.com (full disclosure--I am a client) are often more articulate than moi, I'll let them do the talking--I've got a house to get built.

The Real Risks

10/9/2007

Story Outline

• “Credit crisis” headlines are being replaced by economically insignificant headlines, signaling a lack of legitimate negatives to report.



• Legitimate market risks are few, and unlikely to impact the market much at this point. The risks for aggressive legislation and a major monetary policy error remain low.



• Positive fundamentals currently far outweigh potential market negatives.

Anyone else notice the “credit crunch” headlines are starting to go away? They’re still out there, but no longer occupy top billing, chased off by Britney’s child custody saga, Pamela’s quickie Vegas nuptials, and harrumphing over stores gearing up for Christmas in October. This is front page stuff from allegedly “legitimate” news sources! Very bullish. (For more, read MarketMinder commentary “What a Week,” 10/05/2007.)

We spill barrels of virtual ink at MarketMinder underscoring why now’s a great time to be bullish and pointing out glaring flaws in popular bearish views. As we’ve covered here, popular concerns such as the credit crisis, a weak dollar, allegedly slowing US growth, trade deficits, debt, and even terrorism don’t have the market impact folks think. (For more, you can refer to our commentary archive.) But that doesn’t mean we’re blindly bullish. Rather, we see that legitimate risks are unlikely to develop into major market negatives right now and are far outweighed by positive fundamentals.

For example, we’d view an aggressive legislative reaction to perceived subprime problems as a legitimate risk. Our senators vow to “solve” subprime by forcing banks to tighten lending standards in order to protect the “little guy.” (Pardon us, but who is going to protect the “little guy” from the Senate?)

In our view, any attempt to limit credit access could have negative economic and market consequences—perhaps serious. Is it time to pack it in, go to cash, and safely watch the political melee from the sidelines? Not at all. As we’ve discussed here in the past (“Veto Power”—10/04/2007, “A Political Punch”—05/31/2007) third and fourth years of presidents’ terms are famously feckless. We nearly always see the president’s party lose relative power in the mid-terms—donkeys and elephants alike—setting up the perfect recipe for political gridlock. The political furor over subprime is likely to devolve into nothing more than inane investigations and name-calling—a very good thing if you’re a fan of rising stock prices.

The same goes for rising protectionism—another legitimate market risk. Though congressional cries to “save American jobs” may increase political contributions in the near term, efforts to hinder globalization will likely have an ugly economic outcome. But for now, third- and fourth-year politics should keep ill-considered protectionist legislation to a minimum.

What about a case the Supreme Court is hearing today—being called the Roe v. Wade of securities law (i.e., unique in its far-reaching significance)? In StoneRidge Investment Partners v. Scientific-Atlanta, the plaintiffs argue investors have the right to sue third parties—accounting firms, investment banks, consultants, vendors—if a public company commits fraud. If the plaintiffs succeed, it could mean open season on big business and an exponential increase in frivolous lawsuits. (Great news for plaintiff’s attorneys! Bad news for pretty much everyone else.) Imagine what companies would have to do to protect themselves from litigation. CEOs would become prohibitively risk averse—which would likely reflect in lackluster earnings growth and stock prices.

StoneRidge: Don't Look For a Landmark Ruling
By Brian Wingfield, Forbes
http://www.forbes.com/home/businessinthebeltway/2007/10/08/stoneridge-lawsuits-supreme-court-biz-wash-cx_bw_1009scotus.html

However, we agree with this article’s assessment that the Supreme Court is highly unlikely to rule in favor of the plaintiffs. A 1994 precedent and two recent lower court decisions make it easy for the Supreme Court to rule against the plaintiffs and in favor of capitalism. Another risk moderated. (Though we’ll watch the Court carefully on this.)

Another risk we see is a massive monetary error—like the Fed aggressively tightening or even dropping rates dramatically. We view this risk as slightly higher now, though still unlikely. Mr. Bernanke will be the first Fed head up for reappointment in the first year of a president’s term, as opposed to the fourth year (thanks to term limits imposed on Mr. Greenspan). Ben’s recent cut might have been a signal to presidential candidates, “Hey! I can be accommodative! You want to get reelected to a second term? You need a pleasant economy in the first—and I’m your guy!” If he is indeed auditioning, he may very well cut rates again. But, we still don’t see a few rate cuts as a major deal. First, they take a long time to be felt. Second, inflation has actually been dropping over the last two years. We can’t see how another cut or two will ignite inflation radically from here. File “major monetary policy error” under “still highly unlikely.”

None of these seem likely to flare into major market conflagrations at this point. And they pale in comparison with healthy fundamentals like a growing global economy, strong corporate earnings, and attractive equity valuations. Add to the mix a historically unique positive gap between earnings yields and bond yields globally—which contributes to shrinking stock supply—and a lack of economically significant headlines, and the bears don’t stand a chance. Neither does Britney’s custody case, by the way, but as long as she hogs headlines and fundamentals remain positive, we’ve got a nice ride ahead of us.