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Not so long ago a triple
point gain, like the one that occurred last Wednesday or a similarly sized
loss, a healthy correction that hasn’t happened in far too long was
serious news indeed. The math suggests why. A 100 gain/loss when the Dow was
at 8000 represented a 1.25% move whereas a similar gain in the 13,000 point
range coughs up half as much of a move but twice the chatter.
With the Dow setting new
daily records and the S&P 500 now in the same territory, one wonders what
kind of news will move traders do change course. What economic tidbit will
convince them to pile in with ever greater abandon or take their money and
head for the exits?
It seems as though
nowadays, market-moving news is almost a non-event.
Yet, there are some
interesting contrasts at work in today’s marketplace.
Liquidity is very much at
play in the stock market. And not the kind of liquidity that allows all
investors to jump in with the same advantage as the institutional big boys
and girls.
No, this liquidity has an
entirely different ring to it. Long time readers of this column will already
know how I feel about stock buybacks, the single most disruptive force at
play in the markets today.
For those who have not been
following this trend and the S.E.C. seems to be among those who either are
unaware or who have chosen to look the other way, buybacks work like this. Companies
give guidance to analysts. Analysts determine a target price for the stock
depending on where the equity is at the moment and where it might go in the
future.
Investors, mostly the
institutional types take the info and buy or sell the stock accordingly. But
should those companies miss that number for one reason or another, the
analysts gets skewered, the stock drops and the company is left explaining
what went wrong.
But suppose the company has
some cash in the coffers (we’ll assume the reason may be just as simple
as having a good year profit-wise). Suppose that company, understanding the
simple math of price/earnings ratios – an equation that take the stock
price and multiplies it by the total number of shares available at any one
time to purchase, decides to use the cash to buy back some of those shares.
The stock doesn’t go
away but it is no longer available to the investor for purchase. In other
words, the liquidity of the stock has just been diminished.
There are numerous
scenarios a company can pursue with those missing shares but the move has a
net result: an increase in the share price the next time the P/E calculation
is done.
This leaves two investors
on the short end of the equation: the investor who may be eyeing the company
as a potential investment and the investors who are already in it. The
potential shareholders are looking at a stock whose price is now artificially
inflated. The shareholder, who is the technical owner of the company, will
not receive the portion of the profits they rightly deserve.
The second half of the
liquidity problem comes from overseas. The foreign investor, flush with cash
from trade deficits, oil prices, and outsized growth has few places in which
to invest. Pouring money into a market that rises on whatever news, good or
bad, weak or poor is simply a problem of choice.
Henry Paulson, the US
Treasury Secretary, who has been attempting to loosen the regulations at play
in the US markets, should take note. There are few places to go other than
Wall Street with huge amounts of cash.
For now. If and when bond
yields head towards 5% and that possibility looks very real, this whole
scenario might unravel. As the Fed waffles on its economic stance –
housing is bad one day and not so bad on another; inflation is contained but
not as much as the bankers would like; the economy is weak but may not be for
long or may be weaker than anticipated, the markets rise. They may start out
weak but have rarely ended so.
With so many cheerleaders,
so many companies involved in these types of legal stock price manipulations,
and so little reliable news, the market will go higher. Tomorrow and the next day.
Until…
Paul Petillo
www.BlueCollarDollar.com
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