Oh, I Give Up!

I hate stocks. Not individual stocks, mind you, but the market and the way it trades. It's being manipulated, you know - by the talking heads and self-interested traders on Bubblevision, by Hank Paulson, by Ben Bernanke, by George Bush and Barack Obama, and by every economist out there. Well, practically every one; Nouriel Roubini, Joseph Stiglitz, and yours truly are some exceptions.

Think I'm just crying "conspiracy theory?" Well, think again.

Late last year, when the market was melting down, Bush's comforting comments were always timed to come before the opening bell. Hmmmm ... coincidence? And remember when Hank was pushing for the TARP to get passed "before the market opens Monday morning?" Heck, he wasn't even being coy about it!

This morning, there was a trader on Bubblevision, being interviewed by the vapid Mark Haines and whomever was subbing for Erin Burnett. The trader - commenting after the Bureau of Labor Statistics had informed us the US economy shed 524,000 jobs in December, even more than that in November, and that unemployment was at a 16-year high - said something along the lines of, "Look, this economy's bad, we're going to see a lot of jobs lost, earnings are going to be terrible, but you just have to discount that and determine that this is a good time to get into the market."

Huh?

He also cited the so-called January effect, which holds that stocks will rise in January, because investors who dumped stocks in December for tax purposes will jump back into the market, and the buying pressure will bid prices up. The fundamental flaw in the theory is that it ignores whether we're in a bull or bear market. In a bear market, those investors may not want to get back into stocks, if they believe earnings will be too weak to support valuations. In fact, the January effect hasn't worked so hot for the past several years - which the trader acknowledged, but insisted that this year will be different.

If you believe that, Charlie Brown, Lucy's holding the ball, and you can run up and kick it.

As for the economists, what they're doing is baking increasingly pessimistic forecasts into the data. For most of the past year or more, they were just the opposite - too optimistic. Why? Aren't these guys pointy-headed, scientific seekers of the rational truth?

No, most of them are bank employees. And banks make money when people are borrowing willy-nilly. So the economists hid how bad things were likely to be, so that you and I would keep borrowing ourselves to the hilt, blissfully unaware of the coming economic carnage.

And with every monthly data release came news that was much worse than forecast. And every time that happened - at least for the significant releases - the market tanked. A prime example of this was the February 5, 2008 release of the ISM Non-Manufacturing Index for January, a measure of the health of the service sector. The index plunged unexpectedly that month, falling to a level that suggested the service economy was in contraction - not surprising, since so much of the service economy is made up of lenders, and mortgage lending had ground to a halt. The Dow fell 360 points that day, a decline that isn't that shocking given the volatility we saw late last year, but it was a real stunner at the time.

Now, the economists (and the banks that employ them) realize that people aren't going to borrow in the near term. So, they're trying to keep the stock market from going into free-fall, which will only spook people more. Get stocks to signal that the recession is at its trough, and we're starting the recovery process, and people will smile again, and max out their household debt again.

How do you do that? Simple: the market doesn't like it when numbers come in worse than expected, but it does like it when numbers are better than expected. So, as a fraternity brother once advised when some of the pledges couldn't get dates for homecoming, just lower your expectations! The economists are now baking in very disconcerting forecasts, trying to avoid the unwelcome market reaction to a downside surprise - and in fact trying to manipulate a favorable reaction by creating an upside surprise.

But whether a number meets forecast or not simply tells us the extent to which the forecasters were wrong. A number that comes in better than expected simply tells us economists erred on the low side, and vice versa. Understanding their motivation helps us realize that sometimes, the errors are intentional.

The bottom line is that the number is what it is. We should look at the level of the number, not the level relative to the forecast. This morning's jobs report was a good case in point: payrolls fell less than expected - but it was still an enormously ugly number. And it's not like the market tanked when it first saw the consensus forecast.

This morning's data actually gives us a peek into what we might expect for the economy and stocks over the course of this year. The jobs data, of course, was sobering. We shed more than 2.5 million jobs in 2008, more than any year since 1945 - yes, I said 1945 - and wiped out every job created from the second quarter of 2006 through the end of 2007. And 1.9 million of those losses came in the last four months of the year alone, and were accelerating into year-end.

Now, several big retailers reported that holiday sales were awful, and that 2009 earnings are going to be even lower than they last told us. Macy's is closing 11 stores - probably more before it's all said and done. Even Wal-Mart is hurting, so it's not like people are just eschewing luxury purchases - they're not even buying cheap stuff.

Okay, so do you think that's going to get better with more people out of work? And, those stores that close, do you think they're going to retain all their employees? Of course they're not. So - more joblessness. Which means less buying of stuff. Which means ... etc. And that's ignoring the fact that planned layoffs in December were up 275% year-over-year. We haven't yet heard from these retailers.

The other number that came out this morning was Wholesale Inventories for November. Now, not only is this a relatively stale number, since it's now January, but it's typically not a big market-mover. But even this mundane release carries some chilling evidence of what's to come.

Looking at inventory growth year-over-year (a less "noisy" measure than the monthly change), we see that wholesalers have being doing a decent job of late in bringing down the inventory overhang they were facing. It's not like they hadn't cut back; they just hadn't cut back enough. They did not anticipate the sudden collapse of demand that materialized in the second half of last year. So inventories year-over-year began to balloon, reaching an 11% pace by August.

Since then, as I said, they've been coming down, reaching a 6.3% pace by November, which is pretty close to normal.

The trouble is, in terms of the flip side of the inventory equation - sales - this ain't "normal."

Sales are falling much faster than companies can clear inventories, so the inventory-to-sales ratio has been climbing rapidly, even as inventories themselves are shrinking. That means companies have to reduce inventories by not making stuff, since they can't reduce them by selling stuff.

And when companies aren't making stuff, they lay off their workers and idle their plants. And the spiral continues.

So it's going to get still uglier in 2009, uglier than the stock market reflects at current valuations. But hey, just discount that and dive right in.