First we had the banks, then AIG. Last week, American Express got in line, and now we have the once mighty General Motors burning rubber all around Washington, D.C., begging for a handout. It's no wonder that investors are still sitting on the sidelines trying to figure out exactly what is going on.
The financial markets are still being roiled by four significant challenges. The first is the barrage of selling by hedge funds. As you are no doubt aware, hedge funds, by their very nature, repeatedly borrow money to make additional investments. That's called leverage. When one or more of these investments goes sour, the fund has to sell some holdings to pay off part of their debt, lest they get behind on their payments. Selling stocks in such large amounts pushes prices downward.
The second item depressing stock prices is the whole concept of the bailout. Most people agreed that the government had to intercede in helping keep the financial industry alive and functioning. What is troubling to investors now is the specter of General Motors expecting the government to bail them out too.
Where will this end, with Aunt Tillie's Dress Shop? GM is the poster child for corporate arrogance and union selfishness. They have been making inferior cars for generations, and the public has been voting with its feet by eschewing the big three while switching to better-made foreign vehicles. As Secretary Henry Paulson said last week, the bailout plan was designed to rescue the financial system, not to temporarily prop up manufacturing companies that cannot otherwise be saved.
The third problem with the stock market is the justifiable concern about corporate profits during this recession. Corporate profitability is down 40 percent from last year and most likely will fall further. Stock prices are a multiple of corporate profits, so it is logical to expect that they would fall in concert with the underlying earnings.
The last depressant is the proposed tax policy of the incoming Obama administration as it relates to the economy and investments. Since the election, the Dow, S&P and NASDAQ are all down about 15 percent. The Wall Street Journal recently said that "No president-elect in the post-war era has been greeted with a more audible hiss from Wall Street."
While other factors cited above have certainly contributed to the market's swoon, the Journal suggests that "If Mr. Obama wants to reassure markets, he could announce that he won't be raising taxes for the foreseeable future."
Given that there are few capital gains to be taxed, what has Obama got to lose? The Journal continues, "What markets want to see from Mr. Obama is a sense that the seriousness of this downturn is causing him to rethink the worst of his anti-growth policies." Barron's, the erstwhile sibling of the Wall Street Journal, suggests eight points for Obama to consider. Our favorites among them are;
Support an immediate $100 billion stimulus package. Be prepared to launch another one in early 2009, if needed.
Invest $25 billion each in GM and Ford, but demand concessions from labor, management and shareholders. Let Chrysler merge with GM or a foreign company.
Help homeowners by allowing the Treasury to inject $100 billion in bailout funds into banks to reduce mortgage principal for borrowers in arrears. Require participating banks to use $50 billion of their own capital.
Move ahead immediately with tax cuts for the middle class. Delay any tax increases until at least 2010.
Don't approve a law outlawing secret ballots for worker votes on whether to join a union. Such legislation would cripple America's economy.
All of these moves would go a long way toward restoring investor confidence in the short run.
As we have been telling our clients, we will probably retest the market lows, and if successful, a dramatic rally will follow. If markets sink much below the previous lows, we may see an equally dramatic sell-off, leading to an even more dramatic surge upward. We are getting very close, so we'll soon know.
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William T. Ryan is president of Ryan Financial Advisors in Andover. The owner-managed firm provides highly individualized wealth-management services and financial advice to families, individuals, corporations, trusts and pension plans. Reach him at 978-475-1500 or by e-mail at wtryan@ryanfinancial.com.
