"Is the Market's Non-reaction to the Goldman News Sending a Message?"

Sydney M. Williams

Thought of the Day

“Is the Market’s Non-reaction to the Goldman News Sending a Message?”

April 20, 2010

As fascinating as all the commentary has been on Goldman’s alleged commitment of fraud – which has quickly become overanalyzed – has been the reaction of the financial markets, or, rather, the lack of reaction. It could be, since the SEC was divided along Party lines in bringing the charge, that investors expect the charge will fail. Or it could be that investors are simply comatose; perhaps they have become so inured to the nefarious behavior of those on Wall Street that they feel there will be no lasting consequences – that the alleged perpetrators will remain in their Park Avenue apartments and Greenwich homes untouched by the financial pain inflicted on their “innocent lamb-like” customer. (I recognize that is a gross hyperbole – most institutional investors are not victims. They are savvy and do their homework; the phrase is used to make a point.)

Despite the Goldman news, the Dow Jones closed down only 126 points, or 1.13%, on Friday. The last time the DJIA closed down more than 1.5% was February 4th. The last time those averages closed up or down more than 1.5% was February 16th. Volume and volatility have been declining for months. The VIX between February 16 and last Thursday declined 28.6%. It rallied 15.5% on Friday, but sold off 5.6% on Monday. Volume on the NYSE spiked to its third highest level of the year on Friday, but on Monday returned to the somnambulism which has increasingly come to characterize the Exchange.

Not only did we have the Goldman news on Friday, but we had the eruption of a volcano in Iceland, which lies under the unpronounceable Ejfjalllajokull glacier. That blow-out has caused the cancellation of 81,000 flights and the loss of millions, if not billions, of dollars for exporters around the world and devastating for a Europe struggling with recovery. China, an increasingly critical global participant, over the weekend took steps to cool a surging residential real estate market by raising rates and limiting capital. On Monday, the markets yawned. (China didn’t, but Europe and the United States did.)

Treasuries gained on Friday, as fear gripped markets, but then sold off yesterday, as fear dissipated. Gold, normally a commodity investors rush to in times of peril, declined on Friday and continued its modest sell-off on Monday. The Dollar has been a modest beneficiary of recent news.

A consequence of the Goldman news will likely be a hastening of increased financial regulation, but instead of scaring markets, as such news historically would have done, they seem to be comfortable with the concept of more regulation – an opinion with which I am in agreement.

Economically, things continue to improve and whatever the ultimate decision about Goldman it will have little impact on the economy. Keep in mind, the growth of the financial services industry over the past couple of decades, with its proliferation of myriad derivative products, outstripped the real economy. In other words, a substantial portion of the debt created by Wall Street – the reported $450 trillion in notional value of derivatives – did very little to augment real, lasting economic value. A downsizing of those products and markets will have little long term economic impact, except to those immediately affected.

An old adage says, never short a dull market and this market certainly qualifies for that adjective. But investors would be wise to remain alert that dullness does not become complacency. It is not where we are at this time, in my opinion, for skepticism persists, but one should be vigilant. There are other risks out there. Federal debt and the Federal deficit, relative to GDP, are at levels not seen since World War II; the risk of reflation cannot be dismissed. Fed Chairman, Ben Bernanke, a student of the Depression will do everything to avoid deflation (as well he should), so the risk, in my opinion, becomes one of inflation. Growth in deficits will lead inexorably to rising taxes. There is a (unquantifiable) political risk of Congress relinquishing power of the purse strings to the Executive branch.

Treasuries and Investment Grade Corporates provide very little return should the Fed misread the strength of the economy and inflation returns. Value stocks with low P/Es and decent dividends look attractive. Increasingly, I am being told that cash makes no sense, as it returns nothing, but neither does it lose value – except in an inflationary environment – and it permits opportunity. Risk always lurks, usually in dark corners, as some Goldman clients discovered to their dismay; so the watchwords to heed are caveat emptor.