The Obama Honeymoon Is Clearly Over

Last week the Dow was down 6.2% and the S&P dove 6.9% as investors became more impatient with the stimulus plan and the lack of details from the Geithner bailout. Companies such as J.C. Penny and Lowe's posted weak profits while the New York Times cut its dividend. Earning this quarter have been horrible and we can expect that trend to continue for the rest of the year and into 2010. By now, it is apparent to anyone who lives on this planet that the economy is weak and getting weaker. Unemployment is on the rise and double digits are likely by next year. There does not seem to be any glimmer of hope anywhere as housing remains weak, manufacturing has stopped, and HP's negative earnings surprise doesn't bode well for the technology sector.

The commercial real estate sector is soft but the true pain is coming. Rents are coming down and vacancies are rising. The next year or two should see a huge downdraft in this market. We have been saying for a long time that the corporate default rate will rise to 15 to 20% and it seems like the bankruptcy pace is picking up steam as Trump Casino came crashing down last week. Many more chapter 11's are in the cards as this year progresses. Sirius Satellite was saved from a bankruptcy by Liberty Media infusing expensive capital while also taking a 40% ownership in the company. These are the opportunities for companies or funds with large stashes of cash. Warren Buffett may have been profiled for his similar investments in GE, Goldman, USG, and Harley Davidson but companies or funds with cash will be looking to structure similar transactions throughout 2009. In fact, we believe this strategy is one of the prime opportunities available to cash rich investors.

The biggest driver of falling stocks last week was once again financials. The financial crisis isn't going away easily no matter what the government says or does. Many banks need to clear out the toxic assets which will result in a need to be recapitalized. The government may have injected capital into financial institutions but more will be needed. The biggest fear last week was Nationalization of the banking system. The definition of Nationalize is to transfer ownership or control to the government. We don't know what is going to happen but we can interpret what has already happened. With each injection of capital into the banks, the government has taken an equity stake along with a preferred stock investment. In most, if not all of these banks, the market capitalization has gone down significantly after such investment. Any new investment should result in a much larger equity stake for each dollar invested by the government. Hence, we can argue for or against Nationalization but the facts show that our government is steadily increasing its ownership and control of the banking system.

It is time for Treasury Secretary Geithner to confidently address the issues and win some investor support. We need facts on his plan to buy assets with the private sector. Perhaps in addition to pooling the governments money with private equity funds and hedge funds, the government should create a new fund for any accredited taxpayer who would like to participate in the bailout. There are many wealthy investors (perhaps less wealthy than they were 18 months ago) who might want to invest alongside the "smart money" and take advantage of a once in a life time distressed opportunity. This fund could potentially add billions to the governments efforts to find private money to help clean up the distressed assets on banks' books.

This week could potentially be just as frightening to investors as last as the S&P is only 18 points from hitting its November 20th low. The DOW already is in new territory and many investors are hoping for a bounce. Ironically, panic didn't seem to be anywhere and we would think it may show up again before the absolute bottom actually is hit. Many months ago we thought Apple needed to have a big negative earnings surprise before the market could bottom and perhaps the company will meet those expectations in their second quarter. Until then, we expect choppy waters ahead. Two weeks ago we wrote that we became very negative on the economy and the market after going to the J.P. Morgan Credit Conference. Unfortunately, our intuition has been right in the last couple of weeks and unless a miracle occurs, the economy will continue to deteriorate and the markets will hit a new low before resuming a sustained upward trend. Of course, President Obama could bring some good short term news to create another bear market rally and one that most investors would like to see.