Earnings this Week

There’s no doubt that there are investors who believe that current
valuations for stocks and an improving economy offer money-making
opportunity. It’s also true that there are plenty of investors who feel
the exact opposite and are selling stock. And for the last three weeks,
the sellers have been winning.

The fact that stocks couldn’t
hold a 1% gain after a stellar 4Q GDP number on Friday is a little
worrisome. That was a lay-up for the bulls, and still, stocks finished
the day with losses.

Volume has been stronger on the down days
lately, and the S&P 500 is now well below its 50-day moving
average, a common measure of support. I expect we’ll see stocks bounce
before Dow 10,000 is breached to the downside.

But at the same
time, there’s nothing magical about Dow 10K. Just because it holds on
the first test or two doesn’t make it an important line in the sand.
The Dow is just 30 stocks. Far more important is the S&P 500. And
interestingly, there is an important support point at 1064 on the
S&P 500. And 1071 actually lines up with Dow 10,000 nicely.

Low Rates to Continue

I managed to catch part of Treasury Secretary Geithner’s
testimony yesterday. I actually thought he represented himself pretty
well. I can appreciate his stance that AIG really was to big to fail.
But that notion that the New York Fed had to make sure all of AIG’s
credit default swaps were paid still doesn’t make sense.

Geithner’s explanation was that if AIG did pay off debts like
the $25 billion that went to Goldman, AIG would get downgraded and it
would become more expensive to unwind the company. Maybe I’m wrong, and
I haven’t checked to be sure, but I’m pretty sure AIG’s debt was
downgraded. And do you even need a rating for a company that’s 80%
owned by the government?

Bottom line: I still think former Treasury Secretary Paulson
made sure Goldman Sachs got paid and it really stinks that tax payers
get taken advantage of like that. Unfortunately, it’s unlikely anything
will come of it.

*****The Fed reiterated its pledge to keep
interest rates low for an extended period. No surprise there, but
investors liked the news. Stocks finished the day with a nice rally.

Still, it’s not like the Fed is keeping the liquidity spigots
wide open. The Fed plans to end its mortgage-backed securities
purchases. With so many stimulative monetary policies in place, low
interest rates will probably be the last thing to get changed.

*****China
is also d oing its part to soothe investors. According to Bloomberg,
China’s banking regulator has told lenders to "….step up scrutiny of
property loans while pledging to satisfy "reasonable" financing
needs…"

Watch ‘Em Squirm

I plan to be unavailable for a few hours, starting around 10 a.m.
this morning. I want to hear the members of the New York Fed try and
defend their actions regarding the AIG (NYSE: AIG) bailouts in front of Congress.

The New York Tines published
some of the prepared testimony of the principal players. I try to keep
a level head, but I’m reaching for my pitchfork and torch right now.

*****Recall
that the New York Fed orchestrated what ultimately became an $85
billion bailout. A good portion of that cash was paid directly to other
companies with which AIG had entered into the now famous credit default
swaps. These were essentially insurance contracts on mortgage backed
securities held by banks and underwritten by AIG.

A full $25 billion in AIG bailout money went to pay off Goldman Sachs (NYSE: GS). Here’s a section from the New York Times (Mr. Baxter s the general counsel for the NY Fed):  

Mr.
Baxter explained that the New York Fed felt compelled to pay out
A.I.G.’s counterparties in full to unwind tens of billions of dollars
in derivative contracts because "there was little time, and substantial
execution risk and attendant harm of not getting the deal done by the
deadline of Nov. 10." That was the date when A.I.G. was scheduled to
report its earnings and could face downgrades from credit ratings
agencies. A downgrade would have led to more collateral calls and even
greater liquidity problems for A.I.G., Mr. Baxter said.

“Burn the Hands”

Yesterday, stocks recovered a little from last week’s sharp sell-off. A little time over the weekend to reflect on the true potential of the "Volcker Rule"

(the name given to the new banking regulations proposed by the President on Thursday) to become law probably helped. 

Stocks gained slightly even though December home sales dropped a worse than expected 16%. That’s a pretty bad surprise, but stocks shook it off. That suggests to me that last week’s sell off may have been a bit exaggerated.

As an aside, I’m not sure why there was concern that Fed Chief Bernanke wouldn’t be re-confirmed to his post. Sure, Geithner might be on the way out, but that’s no big deal. I see zero percent chance that Congress would let Bernanke go at this point. 

*****Fourth Quarter earnings have been good so far. I read that 70% of companies reporting have beaten expectations. But many of the surprises have been met with selling, like IBM (NYSE:IBM) and Google (Nasdaq:GOOG).  

Re-pricing Banks

It’s clear that investors are re-pricing stocks for the possibility that the proposed restrictions on banks’ trading practices will impact their profits in the future. The UltraShort Financials ETF (SKF) has rallied 11% in 2 days.

Yes, bank stocks are getting hit pretty hard. But Obama’s proposed restrictions aren’t yet law, and there’s plenty of reason to believe he won’t get everything he wants. More about that in a minute…

But first, I want to point out that this situation is how the "buy the rumor, sell the news" dynamic starts. Now, granted, this is a reverse example because investors are selling stock in anticipation of bad news rather than buying ahead of good news. Still it’s a good example of how investors are pricing in a worst case scenario now, before any proposals have become law.

I think we can expect to see bank stocks rally once the reality of ay proposed restrictions is finalized. But as we know, investors don’t like uncertainty.

Can’t Ignore This One

You’ve probably noticed I tend to stay away from political debates. And with good reason. I learned a long time ago that it’s best not to talk politics and religion. And besides, carrying a political bias into your investing and trading will affect how you see things, and make you more prone to mistakes.

For instance, think about all the investors who were up in arms that the dollar would crash because of the amount of debt the government’s been taking on. I haven’t published that Dollar Index chart in a while, let’s have a look…

Federal Department of Goldman Sachs

The Federal Department of Goldman Sachs (NYSE: GS) beat earnings
expectations with a $4.79 billion profit for the 4th quarter. Goldman
has strong gains in its investment banking division, which handles
stock and bond underwriting deals. Go figure. With companies selling
debt and stock like crazy to pay off TARP money and improve their
balance sheets, it’s no wonder Goldman did well.

Goldman earned
$13.4 billion for the year. But I haven’t seen if this figure includes
the $25 billion in funneled TARP money it received from AIG (NYSE: AIG)
to pay off credit default obligations (CDOs).

As you know I’ve
criticized Treasury Secretary Geithner for handling the banks with kid
gloves. And the fact that his office attempted to suppress the
transaction that had AIG paying Goldman off with bailout money is more
than just a black eye for him, in my opinion.
President Obama was wrong to nominate him. But you have to wonder how
much choice he had. After all, the Federal Department of Goldman Sachs
is pretty powerful.

Today is the Day

On the surface, earnings from IBM (NYSE: IBM) appeared excellent. The technology bellweather posted $3.59 a share in 4th Quarter earnings. That beat analysts’ expectations of $3.47 a share. IBM also beat slightly on revenues.
IBM also said 1st quarter revenues would be higher and even went so far as to raise earnings estimates for all of 2010. So why is the stock down?
Because IBM’s business services division, which includes consulting, reported a 2.8% drop in revenues. Obviously, strength in other divisions more than made up for it. But investors seem fixated on the negative.
Yes, the drumbeat of the skeptics rolls on…

Bearish on Oil? Don’t Be…

The AP article starts off: Oil prices fell below $78 a barrel Tuesday amid the strengthening dollar and continued doubts about global demand for crude.
If "doubts about global demand for crude" only succeeds in taking oil prices down a couple of dollars per barrel, I have to wonder why the financial media continues to take a bearish stance toward oil. Oil prices have been climbing the proverbial "Wall of Worry". Inventories rise, and yet so do oil prices.
Oil is becoming a "store of value." Buy it, store it and sell it at higher prices seems to be the consensus. That doesn’t bode well for the oil bears, unless another cash crunch forces traders to liquidate positions. I expect oil and energy prices to remain strong.
*****Earnings may not have recovered to pre-crisis levels, but cash flow has. Bloomberg reports that the 2010 P/E for the S&P 500 is 14, based on company estimates. The trailing P/E sits at 25. Both imply stocks are fairly valued at best, and may even be overvalued.
But if we look at cash flow, defined as earnings plus the cost of depreciation and asset write-downs, stock valuations look much better. Bloomberg reports that valuations based on cash flow are 37% lower than its 12-year average and 50% lower than in 2007.
Bloomberg goes on to say that the discrepancy between earnings and cash flow is because companies are still grappling with expenses related to the financial crisis. Just today, Citigroup (NYSE:C) reported a $7.6 billion quarterly loss because of TARP repayment expenses. Another example would be companies that have laid off workers will also be subject to severance expenses.
 

China Must Play Ball

Yesterday’s Daily Profit about Google’s (Nasdaq:GOOG) experience in China has raised some questions. Ray G. writes:
Anytime a government like the one China has can do whatever it pleases with any company in its country, the playing field is too much of a mine field to be attractive to me.
It is difficult enough for the individual investor to make money in any market but to try to do it in a country where one doesn’t understand the playing rules is sheer madness.
Good luck because you will need it.

I believe this question reveals a common misconception about China’s government. The simple fact is that China’s government can’t simply do "whatever it pleases". China has an export economy. It is dependent on countries like the U.S. Without foreign support, China can’t provide jobs to its people. It fails and collapses. In other words, China has to play ball.
In exactly the same way, China is dependent on foreign investment in the country. It must gain both the capital and the innovation of the West. Without that, again, China collapses. China must play ball.
And this is why Google’s stance on China’s attempts to "control" the Internet is so significant. I wrote yesterday that Google needs China more than China needs Google. But that’s not entirely true. If Google actually leaves China, it will be very embarrassing to China. And that’s more important than you might think…