28 August 2010

Dow Valuations and the Recovery

Are the methods used by the Fed harming the real recovery ? All they really can do is add more liquidity to the system and indirectly or directly value $ (and hence every other currency in the world, such is the power of the Fed). Is it just the eternal problem, government money does not seem to get used efficiently ?

Yet from what I can see TARP money was used in a spectacularly efficient way. I do not think one can underestimate the trouble major banks were in during the crisis and the effect one going under would have had on the world economy. Now whether this trouble has gone away is another matter, but the point of TARP was not to solve those problems.

The Fed operated most efficiently as a normal bank with a heart providing emergency loans and liquidity. That is why Friday cheered me up, because they do this well and they feel the economy may be reaching a stage where this may be necessary.

But I most certainly agree with them about the recovery being alive, I have been saying this for months. It is just the fundamental question can deep recessions be avoided, and if they are avoided do they simply come back even harder. That does seem to be what happened in 2008. Let's get technical.

Look at the Dow chart over its lifetime (e.g. on MSN Investing: Dow on MSN). If one looks at the linear scale then it looks like the Dow is charting a head and shoulders. However that is computationally less likely. Why, well it would have to plunge down to values which the Fed simply won't let happen, and which would make great companies so undervalued, they would bounce way up again (look at what happened to EME, for example, in the crisis).

If it didn't happen when the credit markets froze and the hedge funds were hit by margin calls in 2008, then it is unlikely to happen now. The log scale gives a better perspective and here we see something encouraging. Just a bump on the road, not the end of the capacity of the Dow to compute value upwards. This blog has discussed this at length and concluded that capacity is alive and well, using specific examples of the financial statements of quality companies, like JEC, JOSB.

If you want to put this in historical perspective and assume that the Dow does have structures which reference events in the past, then look what the real problem is. Look at the problems Dow had at 1000. It is experiencing similar problems at 10,000. This is a huge technical level.

One can discount this by saying that is all it is. But there is evidence for the fact that this level has a real significance, a significance related to the way the market grows as a complex referential system. How could this be, it is just a number ? It isn't for investors, market makers, traders and programs who use it as a price reference for everything, from stocks to options.

That is an input into a system and the system is based on inputs. The market works when it is given inputs, they structure it and feed into its functionality and thus produce its behavior.

This blog has also offered explanations of market behavior right now, the way the market slides back after being pushed up by cheap dollars. During this process I believed this was providing a cushion to let the recovery happen, so despair would not produce toxic valuations of assets. The money went back into sunken assets, but those companies at the forefront of US company creativity or those companies with superb balance sheets do not seem to be harmed.

All this gives backing to a possible belief that this is a computational interregnum and one which will not last for too long.  Looking at that data as the effects of a program, one could conclude that major technical levels become less of a barrier as they are hit. That seems to be a feature of the market.

Thus we can optimistically conclude that the Fed may simply be trying to shorten this interregnum. So far nobody could conclude it has lengthened it. Basically a debt economy ran out of capacity to produce meaningful inputs to the market.

A new investing economy or at least an economy where assets grow, rather than being pumped up by money flow may be on the horizon. This may be the economic spring, but it has been a long cold winter. Remember the Dow has not merely been tested at 10,000, it already went well over it, the epic high in 2007.

That was an extraordinary event as it occurred after the crash had really started. That suggested to me the market had other things on its mind, things to do with growth for the future.

The behavior of oil in that time period is to me further evidence supporting this belief. That valuation and the Dow's looked to me like the process this blog noted in tech, that the market finds a valuation that is a marker for future growth after a retrenchment.

The point of concern I have is the same one expressed in this blog, the effect of Fed policy on the value of $ and its value relative to other currencies (creating conduits which encourage money flow). If there is a way to raise interest rates then the Fed should, but maybe the economy will provide a way.

© 2010 Guy Barry - All Rights Reserved.