02/04/09   Executive Pay Kabuki

Editor’s Corner

Executive Pay Kabuki

Ron Rowland

The line between financial analysis and political punditry is increasingly unclear in 2009.  Markets are now driven less by business fundamentals and more by decisions made in the White House, the Capitol, and the Federal Reserve.  Since these institutions do not emit the kind of quantitative signals needed for normal data analysis, we are at a disadvantage in making any kind of forecast.  The entire landscape can change in an instant based on a single press release.
The idealism of the Obama campaign is crashing into the reality of actually making decisions and then executing them.  Missteps on Cabinet appointees, botched communications with Congress, and mixed signals about its bank rescue plan have plagued the new administration.  On the other hand, given the magnitude of the challenges we face, it isn’t surprising that the White House needs a little time to formulate its strategy.  We expect to see action on a number of fronts soon.  Today brought news of executive pay restrictions on companies that accept “significant” government assistance.  The investment blogosphere wasted no time picking the plan apart for loopholes, and found many.  We suspect this is no accident; it is instead a form of Kabuki theatre.  The government pretends to get tough with the bankers, the bankers pretend to be outraged, and the public is tricked into believing something has actually changed.  It will be interesting to see if this time-tested tactic still works in the Internet Age.
The pay issue is really a sideshow to the broader economic rescue plan that is slowly emerging.  Despite all the noise about pork-barrel spending, the economic stimulus bill should pass through Congress soon.  We predict it will have little or no stimulative effect.  More important will be efforts to salvage something from the wreckage of the banking system through the use of a “Bad Bank” that buys up troubled assets or government guarantees that do the same thing.  In either case, the best-case outcome is a little more time for the banks, bought at enormous cost to the taxpayers.  None of the proposals currently in the mix appear likely to provide long-term solutions.  We will be fortunate if they can just avoid making things worse.
Equity benchmarks have been choppy as this debate drags on.  Financials are in particularly sad shape, but they could explode higher at any time if it begins to look like a generous bailout package will become reality.  Unfortunately, even in the best-case scenarios we are still in a severe recession that will not end quickly.  U.S. Gross Domestic Product for the 4Q dropped at a -3.8% annualized rate, and a buildup in inventories suggests that 1Q will show no improvement.  A successful re-test of the November stock market lows would be encouraging.  Such a test may take place soon.  How successful it will be is anyone’s guess.
Treasury yields have continued to rise in the last week, and we are beginning to doubt our earlier beliefs that this is a short-term correction.  We have always expected rates to rise sharply as the magnitude of government spending brought new bond supply onto the market.  Now it looks like that process may be unfolding more quickly than we thought.  At the same time, Ben Bernanke knows he must keep long-term mortgage rates low if there is to be any hope of a quick recovery.  The obvious solution will be for the Fed to buy massive quantities of Treasury bonds now and deal with the resulting inflation later.  Bernanke keeps threatening to do this; at some point he will have to make good on his threat.  We would not want to be short T-bonds when that happens.
Health Care had a good week and moved slightly into the green on our momentum chart.  Utilities managed to hang onto the #2 spot, but there is a very close four-way tie for third place.  Technology, Consumer Staples, Telecommunications, and Energy are all in a very tight range.  Technology wins the “Most Improved” award this week for its jump from #6 to vie for the #3 spot.  Once again, Financials and Materials are at the bottom of the list.
Most of the style categories improved their absolute strength, which only means they became slightly less weak.  Growth now occupies the top three spots while Value holds the bottom three.  Dispersion is still relatively low and overall trends are negative, so it is not yet time to jump into Growth stocks.
Latin America moved ahead of the U.S. for the #2 spot in our global rankings.  Japan is still on top but is weakening.  Europe is still lagging badly as it becomes clear the American problems are not unique.  Wall Street sneezed, and now the rest of the world is catching cold.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

“Chance favors the informed mind.”

Louis Pasteur


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