The Will To Fail

4/6/2009


 

With profit warnings and profit reports approaching, this month’s price action could prove telling. A breakdown below the March 9 closing lows of 6,547.05 in the Dow Industrials and 2,146.89 in the Dow Transports would reconfirm the bearish primary trend, while a near-term rally could prompt some panic buying from cash-heavy portfolio managers. For now, maintaining a wait-and-see posture, with 30% to 40% of equity portfolios in a short-term bond fund, seems appropriate.

As GM goes, so goes the nation
At current prices, General Motors ($2; GM) has little impact on the price-weighted Dow Jones Industrial Average. If GM files for bankruptcy, Dow Jones is likely to drop the stock from the 30-stock average — and perhaps take the opportunity to remove other deadwood like Citigroup ($3; C).

Good riddance, you might say. GM has been a drag on the Dow for a decade, and Citigroup seems the most unwieldy of the government-supported financial giants. If both stocks went to zero, it would have less impact on the Dow than a 5% pullback in IBM ($97; IBM). Still, there are bad and less bad ways for the stocks to reach zero. As we see things, developments at GM and Citigroup merit close attention, for at least two reasons:

America has a failure problem. From Bear Stearns to AIG ($1; AIG) to Chrysler, U.S. authorities have been afraid to let failed firms reorganize in bankruptcy court. Reflecting fears of financial contagion, some banks have been deemed too big to fail. GM, with a huge work force and politically powerful union, represents a big test for the Obama administration. Will President Obama risk the job losses — and related political fallout — a GM bankruptcy could cause? Or will GM become a ward of the state, an expensive jobs program kept alive for more of the “restructuring” it has been pursuing for the last 30 years?

Free money comes at a price. Financial stocks rallied on March 23 when the Treasury department and Federal Reserve outlined plans to buy bad loans and other problem assets from banks. The rally made sense, as the plan largely amounts to an exchange of banks’ toxic assets for new money created out of thin air by the Fed. For the rest of us, the money being printed by the Fed means the dollars in our checking accounts are being diluted. When more dollars are chasing the same amount of goods, the result is inflation. The Fed says it is worried about inflation being too low in coming months because of the deflationary impact of the global downturn. But debasing a currency at exactly the rate needed to counter deflation is no easy task, especially when inflation helps ease the burden on such influential debt-heavy entities as the banks and the U.S. government.


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