Tag Archives: capital markets

Transformation, efficiency, transactions

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It being the time of year for predicting, planning, and reflecting, two more cents’ worth of prognostication could only augment the mood. Below is a sampling extracted from the past year’s glimpses around media, technology, the economy, and markets, as these may become more sharply focused trends in due course.

Transition & convergence. There is no new media or old media now, and digital media becomes an antiquated distinction when all media turns digital. Mobile and fixed are similarly soft qualifiers, as platforms are increasingly ubiquitous. Video, audio, and print have been converging for years, and data extends across all formats. Instead, the groupings to look for are Information, Entertainment, Social, and rapidly emerging, Transactional media. There has been overlap between these, which we expect to continue. We should think of the sector simply as media, and its components will continue to converge. This has always been the tendency in the sector.

Disintermediation. Media is less about moving content than about moving product. In this context advertising is the intermediation of consumption, a go-between connecting vendors to consumers. This form of intermediation, with its multitude of layers, filters, networks and exchanges, has become inefficient and vastly uneconomic. Because commerce tends to optimal efficiency, consolidation and disintermediation in advertising are probable. Early signals of disintermediation are manifest in coupon and daily-deal platforms. Such transactional media is a form of disintermediation and added efficiency, and the technologies that support it should continue to evolve and grow.

Fundamentals. It would be unnatural for web innovation to sustain the frenzied pace established in the mid-90s and into the last decade. As information flow, devices, media consumption habits, and any opportunities related to these begin to mature, execution will begin to trump invention as the central theme. At this point of diminishing returns, investment theses will become more focused on profit, and investors more attentive to fundamentals. Issues such as pricing, productivity, market share, competitive response, and the incremental development of growth platforms will draw the most scrutiny. Entrepreneurship will be more than ever judged by standards of professionalism.

Liquidity demand. Liquidity pressures for media investors will escalate in coming years. The spike in funds raised during the 2004-2008 timeframe will translate to a spike in exit requirements as these funds mature. For traditional media, depressed values set by purchasers, reflecting uncertainty and increased competition, should lead to further consolidation and restructuring of debt burdens. For newer media, IPO and M&A exits will be increasingly augmented by leveraged recaps as these businesses take on the recurring cash flow characteristics of traditional predecessors. Regardless of exit alternative, competition for liquidity events will increase due to the pent-up backlog of deals in private portfolios and the strategic reconfiguration of the established industry competitors.

Capital flows. Leverage and deficits across major economic segments will foster competition for capital allocations, even as economic performance continues to shape market trends. Liquidity added to the system – domestically and from abroad – will make its market presence felt, but will be systemically offset by fundamental pressures: unemployment and a general movement to reduce leverage. Consumption behavior in this environment will emphasize frugality and efficiency, which will directly impact media and its commercial applications. Investing will increasingly seek out current returns, adding to the profit requirements of ventures. Durations may tighten as early-return or quick-exit potential is increasingly sought. This will evolve into an increased debt-finance market for select platforms.

Hyper-focus. Trends described will cause investment and strategic decision-making to be marked by sharpened focus and long-term planning. Despite substantial corporate cash balances, the pattern of small but hyper-specialized strategic acquisitions will continue, augmented by occasional consolidation plays as suited. For financial investors, attention to future exit parameters and pitfalls that could jeopardize returns will be acute.

Geographical convergence. There are defining hubs in media, based on regional evolution, histories and cultural characteristics. These will remain and possibly grow. San Francisco is the primary center of technology innovation. Los Angeles is the primary center for entertainment production. New York is the national capital of commerce and finance, with an increasingly vibrant entrepreneurial community. New York’s growing presence in the sector is beginning to manifest itself well beyond the confines of Madison Avenue and Broadway. In addition to the international media titans headquartered here, the west coast firms are moving in, and will continue to. Themes such as transactional media and financial structuring are New York themes.

Flexible specialization. In the environment described, investors and bankers will require universal models that combine versatility with deep industry understanding. In an era characterized by transition, execution discipline, and economic risks, the optimal finance approach will more than ever necessitate a wide capital markets perspective, transactional flexibility, and a sector view that incorporates (without insularity) the full experience of two decades in media.

And on that note, we move ahead from past to future. Happy holidays, road warriors, do not take your eyes off the road.

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Bulls and bears in inefficient markets fade

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When markets cease to be strictly compliant with financial fundamentals, accepted standards get thrown to the wind. Among these are the two perennial labels, bull and bear. In a previous post I suggested the possibility of disorientation and a general state of analytic confusion, caused by a divergence between market and economic directions. Under normal circumstances, markets anticipate economies and the two tend to move in tandem. More recently, markets have anticipated governmental actions, (such as quantitative easing domestically and other central bank activities abroad). Based on increased liquidity, currency swings, or political side-effects that such events will trigger, markets have recently moved mainly on Fed or ECB activity, at thousands of trades per second and in ways that often seem to defy reason. I won’t repeat the examples provided and issues of market inefficiency raised in previous posts, but these can be found here, here and here, and further back here, here and several other places.

I am more concerned now about nomenclature: they say that everything which exists has a name. In the realm of market outlook, those who are optimistic are called bulls and those who are pessimistic are called bears. Bulls typically latch on to a certain stock, or index, or economy, and argue for the brightness of its prospects until their audience becomes bored and buys into the position. Bears do the opposite, watching with perverse glee as their audience sinks into a mild depression. In the case of a stock, bulls and bears may take opposing sides of its earnings outlook. In the case of an index, they will have opposite perspectives about average multiples and other composite trends. In the case of an economy, growth and its underlying components will delineate the separation of bullish and bearish positions. If, however, stocks are swept up by the fluctuating tides of broader indices, and if these indices float around on the basis of liquidity that has been or will be artificially infused, and if furthermore economies are expected to be elevated by such indices rather than the other way around, then what does it mean to be a bull? What does it mean to be a bear?

Another way to pose essentially the same question is this: Is one truly optimistic or pessimistic about a stock or an economy when one simply anticipates an arbitrary central authority event? To be clear, these types of events have not recently been assessed, strictly speaking, for their impact on economic efficiency (or the operations underpinning a certain stock). Many observers, if not most, have agreed that QE2, for example, is unlikely to give the economy much lift. Indeed, the Chairman of the Fed said as much when describing it as foremost a way to prop up asset values (i.e., stocks). And this is precisely the point. Watching stocks fluctuate on that basis can’t possibly lead to genuine bullishness or bearishness, can it? Because the cause is capricious, based on the judgment of one, which judgment could just as capriciously reverse.

There has been much publicity given lately to bullish sentiment, and the historical highs that this is reaching. For bulls, this is a show of strength, of support for the team. For bears, this is a contrarian indicator proving that the very end is in sight. I would argue that both “bulls” and “bears” are wrong, and that the measurements themselves are flawed. In an environment in which market efficiency suffers, bulls and bears can only be incomplete, and insubstantial – like silhouettes or transparencies – and any study measuring their sentiment is bound to be vague and ultimately empty.

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Orchestrated market dysfunction and its consequences

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That capital markets are being manipulated is not an inflammatory statement, alas, but a reporting of public policy. Fed Chairman Bernanke explained the central bank’s current rounds of quantitative easing as directly aimed at inflating stock prices. No qualms about it. The ECB may have been less blunt and arguably more reactive when buying up European sovereign debt by the truckloads last week, but the result was not dissimilarly spectacular. Justified or not – undoubtedly well intentioned – such maneuvers may show consequences upon more than just inflated asset values. When financial patterns diverge from fundamental reality, and when markets are replaced by central authorities in a complex web of interests that are not always consistent, the basis for investment decisions, corporate strategy, even consumer behavior, will be shaken. In a capitalist system, we have been trained to think in terms of an efficient market – consciously or not, rightly or wrongly – and thought is prone to become broken when such context and definitions change. Perhaps it is not an exaggeration to suggest that we are now in the midst of general disorientation.

This notion came to mind the other day as I was watching an interview with David Stockman on CNBC. Disappointing employment data had just been released, and Mr. Stockman was describing his analysis of the last several years of statistics, illustrating an underlying pattern that is far worse than is indicated by headline numbers. To his left, the market indices were rebounding after an earlier shock – a classic QE-2 liquidity moment – and to his right the CNBC talking heads were bouncing around in what seemed like a coffee-induced trance, marked by rapid speech and glimmering facial expressions. All of which led to a point of climax that should have been replayed on all the news channels: “I can’t explain the market,” Mr. Stockman said. “I don’t know what it is pricing today, I don’t think the market discounts anything anymore, it is purely a daytraders’ market that is trading off the Fed, trading off the headlines. One day it is manic, the next day it is depressive, and we can’t draw any conclusions.” This from a senior economist and market professional who has spent his entire career at the highest levels of capitalist decision making.

While Mr. Stockman’s statement was direct and almost unusually confessional for an investment pro, the confusion expressed may be of  a similar variety as that which would cause leading economists to dispute what would normally be relatively clear subjects: inflation vs. deflation, expansion vs. contraction, and even matters of technique, such as whether QE-2 is in fact akin to money printing or not. In a different area, a respected stock analyst argued seriously that Groupon’s staggering valuation should be seen in the context of its gross (rather than net) revenue, and then it won’t seem so high. (This is a little bit like making a case that a real estate brokerage should be valued on the basis of aggregate amounts for which listed properties were sold. Absurd? Apparently not anymore.) And venture capitalists are still struggling to determine if (and why) there is a seed-stage investment bubble in the making, if (and why) there is also a late-stage bubble underway, what similarities, if any, the two ends of the barbell contain, and what this all means for the middle-stage that is still mild and murky.

What all of these isolated references underscore is a scenario that surpasses any normalcy of disagreement between participants in an efficient market. In a normal scenario, market participants will disagree on outlook and opportunity, but fundamental standards of measure, basic mechanics, are taken for granted. In a normal market, participants will disagree on valuation, but will not seek to relearn basic precepts in order to substantiate foregone conclusions. These are all symptoms, rather, of an environment in which efficiency has been compromised, and a system that has put in jeopardy the very basis on which it stands: the market itself. An unintended consequence of central bank intervention, at least as profound as any financial ramifications, may be psychological in nature and for that reason more difficult to manage and correct.

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Liquidity and rapid trading in markets and in information

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It is not easy to be precise about where the virtuous cycle ends and the double-counting commences. Sometimes there is overlap, and sometimes it’s all the same. Yesterday’s market, for example, may have contained a bit of double-counting. One of the drivers behind the 170-point rally, supposedly, was business sentiment data that was released around the beginning of the trading session. The referenced survey, conducted largely in the weeks leading to Election Day and official QE-2 messages, very probably reflected the positive vibe that was already in the airwaves (and the market) about that time. Both the election results and subsequent central bank activity were anticipated, discussed, and in no small part responsible for a substantial and prolonged market upswing leading into the October weeks. For the market to surge anew, today – as a result of surveys that were taken approximately at that same time – is to behave as though the original run had not occurred.

Of course, some of the confusion I feel may have to do with causality. The powers that be have in the last several months of policy making and high frequency trading turned causality on its head and upside down. It used to be that the market reflected underlying economic conditions. With QE-2, it is explicitly hoped for the reverse: that the economy will begin to reflect the market instead. And with high frequency trading now constituting some 70% of daily volume, there isn’t much thought to causality per se, or really to anything, but there is rather an ongoing reflex action based on immediate momentum. It seems as though – with monetary policy and machine trading now dominating the market’s pricing mechanism – efficiency is not quite as advertised. Each day I entertain graver doubts about this point, and have explained my skepticism in this space before.

I think, as well, there is another dynamic at play, and the idea came to me as I stumbled upon this blurb (The Curse of Perpetual Nowness) by technology investor and blogger, Om Malik: “… in our constant quest for the hottest, newest, trendiest, sexiest, we suffer from a collective cultural amnesia about what happened five minutes ago.” The statement is self-contained and requires no further elaboration, but I believe it to be reinforced – or, rather, augmented – by a recent article (Giving Every Person A Voice) on Fred Wilson’s A VC blog. In it, the case is argued that one of the Internet’s greatest contributions to society has been its creation – through public broadcast platforms such as for blogging and micro-messaging – of a podium from which all have the ability to hold forth. (Exemplified by my own blogging podium, this is true.)

Here, we should draw an analogy: On one hand, the flow of real and unreal information, valid and invalid ideas, in short, the great noise that has become the Internet; and on the other hand, market liquidity that is forever pumped. Maybe there is in information also a degree of efficiency that is subtracted from the waters, as it were, by too much flow. And if we were to draw another analogy, along similar lines, between high frequency trading and high frequency communication (e.g. Twitter), then perhaps here again the high frequency of missives has a distorting impact. In other words, it is possible that excessive volume and a frenzied pace, rather than adding to the collective’s access to information in fact has the opposite effect. I think this may be what Om Malik was suggesting with The Curse of Perpetual Nowness.

And just as a “perpetual nowness” betrays limited attention and fragmented thinking in our every-day activities, perhaps the same is true of the markets and their limited continuity, their fractured causality and follow-through, that seem increasingly to prevail. Maybe the markets, on certain days – more often, it would seem, than otherwise – are living strictly in the moment.

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The ineffectiveness of signals in a manipulated market

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“Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action… Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will… in a virtuous circle… further support economic expansion.” This is the essence of Fed Chairman Bernanke’s justification for quantitative easing (QE-2), as published in his op-ed piece in The Washington Post the day after details of QE-2 were formally announced.

What Chairman Bernanke probably thought he was conveying is this: “Consumer optimism needs a boost because consumer spending is not lifting the economy as it once did. With higher financial asset values, optimism should increase and with it, so too the economy.” However, as this editorial was written in order to explain a market movement determined by arbitrary policy, what Chairman Bernanke in actuality said was something closer to the following: “We hope consumers will not notice that stocks and bonds and commodities and houses are being propped up by my artificial means, because for optimism to take root consumers should see the rise in asset valuations as a natural and sustainable phenomenon, indicative of an improving economy. Truth be told, I now wish I hadn’t written this column which suggests that asset values have increased (and should continue to) only in consequence of my capricious action.” It’s alright, Chairman Bernanke, almost nobody reads The Washington Post. Besides, the much more offensive subtext of your message (and its underlying action) is elsewhere: the idea of justifiable market manipulation.

This is, as they say, a slippery slope. It’s one thing to set interest rate targets as consistent with inflation ranges, and it’s quite another to openly and deliberately move the value of stocks. Obvious questions arise, which, after a lifetime of efficient market theory, can be disconcerting to even ask. For example: At what point does the Fed arbitrarily not prop up prices any more? What would cause the Fed to make such a decision, and where would values at such a point settle? How does one determine the value of an asset if its fundamentals don’t really matter? How does one gauge market liquidity, (which matters now more than fundamentals), if a primary source thereof is a single entity that makes decisions at whim? In short, what does it now mean, “the market”?

Around six months ago I posted another article in this space, in which I raised similar issues. At that time there was a great deal of attention being paid to the imperfections of rating agencies – their excessive and concentrated power and their potential conflicts – and these themes caused me to wonder then about a point at which influences can become too dominant for an efficient market to exist. These questions should be asked again, but this time in the context of QE-2 and its stated rationale – which is specifically reliant on the effectiveness of market signals. Once market efficiency falters, once it becomes vulnerable to questioning, the effectiveness of market signals is compromised. The Fed’s recent actions are thus, ironically, self-negating.

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New banks for a new economy with old strengths

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It is said that America is good at technology innovation, and it is easy to understand why this is said. Companies like Microsoft, Oracle, HP, IBM, Intel, and a host of others have established a firm competitive foundation dating back decades or longer. It is also said that we are good at media and entertainment – fields that have straddled with technology to form an integrated segment – and major innovation by Apple, Google, Netflix, and for that matter Facebook and Twitter and countless advertising networks and related platforms, have provided ample basis for saying so. Lastly, it used to be said, before the financial turbulence of 2008, that we are good at finance. Say what you will about Wall Street, but it’s had a solid run and has been at the forefront of global money flows for more than a century. Let’s hold on to these thoughts, to which we will soon return.

A couple of financial trends have been observable lately, which warrant attention: While on one hand certain businesses are unable to tap into capital markets for being too small, others, at the opposite end of the size range and with ample access to funding of all sorts, have been hoarding their profits and preserving cash. This latter trend – particular to the present time – appears (interestingly enough) most pronounced in the assortment of sectors identified above, and especially within the group of afore-named technology and digital media titans. (The hundreds of billions of dollars on the balance sheets of these corporations are of special significance, moreover, for being relatively unencumbered: these are all companies with clean and comparatively debt-free finances.)

And so it seems strange – doesn’t it? – almost counterproductive and a missed opportunity, that while important parts of the general economy are in distress on account of either inadequate capital access or too much debt, there is perfectly good cash without offsetting liability just sitting there, and continuing to pile up. This cash, moreover, is being hoarded by corporations with a substantial vested interest in the well-being of our economy.

Where this collection of observations and economic considerations is leading to, is the following suggestion: It may behoove the listed cash-rich technology and media behemoths (and others) to use portions of their cash piles to establish finance companies. In so doing, our national skill set, our strengths in innovation and financial product, would be combined for optimal economic benefit. The subject entities could use their massive excess capital to make loans to small businesses that can support such loans, or equity investments into businesses that need to deleverage or to finance growth but are limited in their access to financial capital, or venture investments in startups that may be constrained by a shrinking venture segment.

It could be quite lucrative for the described companies to pursue such tracks – financially, if the return exceeds that of idle cash, and strategically, if the targeted counterparties represent vertical integration or other expansion opportunities (including local manufacture of technology) or potential customers for end-product. (The model described, incidentally, was implemented with good results – until excesses proved detrimental – by GE Capital for three decades. Excesses don’t negate the idea or model, but may serve as a cautionary tale moving ahead.)

Of course, there is at least one imperfection in the argument laid out, notably in regard to the proposition of idle cash that is hoarded. There is no idle cash, technically speaking, as long as this is not stored in safety-deposit boxes and under mattresses in Silicon Valley. Rather, large quantities of such cash are invested in Treasury securities, and the tech segment is thus already a banker of sorts, only not to the private sector. This is a major issue that needs to be addressed, because competition for private capital from public sector demand does not bode well at all, for any of the parties concerned. But that is a whole other can of worms that would exceed the scope of this narrow article.

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Extended interlude to get our houses in order

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It has become fashionable among the punditry and the cognoscenti to pounce upon the Fed and its Chairman Bernanke as principal aggravators and a long term detriment to an economy and a recovery that are deemed to be mismanaged. The headlines, as headlines have been known to do, compete with one another for greatest splash and ridicule, most recently directed at quantitative easing policies being prepared for official announcement. Although in nuance the opinions range from punchy to stylized to sarcastic to coldly analytic, in substance these are mainly the same. And as most of the missives are the product of reputable market watchers, money managers, and economists with credentials to fill Fort Knox, I would hesitate to find fault with any of their observations. I especially hate doing so as I have tended to agree with their conclusions in the past.

But that’s exactly what now begins to give me pause… Which is to say, if even I can see the obvious misconception of quantitative easing as envisioned, and as Chairman Bernanke is an economist with a history of accomplishment and access to data that exceeds most people’s, let alone mine, then maybe the issue is not quite as obvious as many assume? What if, as difficult as on certain days it may be to believe, Chairman Bernanke and his colleagues actually do understand the difference between economic recovery and an asset bubble? And what if the point of QE2 and the asset inflation it has already caused, even on the mere basis of a rumor, is not economic recovery at all, but asset inflation precisely?

To be clear, I am referring to capital markets and the assortment of bubbles experienced in the last few months. It is true that inflation hasn’t been observed in all of these equally, but the high yield debt market has certainly benefited, as has the public stock market, and the commodities market, and who knows where real estate might actually be if not propped up by artificially low rates. What such an environment makes possible, is for both capital issuers and investors to get their houses in order, as it were, before a (maybe inevitable) second shoe drops – the first having been the already “great” recession. In other words, asset inflation buys time… for corporations to clean up balance sheets or to build cash reserves, for investors to reallocate portfolios, for the IPO pipeline to clear, for universities to fix their endowments, for individuals to do what they can to deleverage.

What if – to continue with this train of thought a bit further – the Fed and other global banking authorities are more acutely mindful of their limitations in fixing economies than some of the critics realize? After all, double-digit unemployment in the world’s most advanced economy is no rounding error, no mere inflation retargeting issue. Sovereign debt crises, or for that matter municipal finance challenges in states that are large enough to be mid-sized nations, these are more than textbook central banking issues like orchestrating a soft landing, (if only!). These risks, and many others, are a continuing overhang that will not go away any time soon, and that are without doubt much more than issues of setting interest rate policy.

As this overhang remains, the event of a second shoe to drop is distinct and plausible. What’s more, fiscal solutions to address known problems are not obvious either, let alone easy. And what a good thing it is, comparatively speaking, that $1 trillion of cash now resides on corporate balance sheets, to use that as an example. What a good thing it would be, comparatively speaking, if the second shoe dropping does not result in massive bankruptcies, bank crises, or other large-scale systemic disruptions. Maybe, in the last analysis, and all things considered, planning ahead and diminishing such risks is a legitimate central bank mandate, and maybe the Fed is doing its job.

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Festivities are getting out of hand

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If the last month or so in the market has been something of a party, we would like, for good reason, the party to never end. If the last twelve months of the economy has been something of a revival, we want that revival, soft as it may be, to continue. The past week has shown the collective’s desire most clearly. While the Fed’s facial expressions have hinted at a willingness to keep the party going, the market has read into these messages and celebrated without pause. While the broader economy will manifest its disposition in upcoming reports, there are early glimpses offered by quarterly corporate earnings, now trickling in with intelligence from the trenches. The markets have taken in these reports, mixed them with the remembered images of a smiling Fed, and decided that the party continues. But the festivity seems based on hopes that are not altogether wholesome, and such parties all too often don’t end on a high note.

That quantitative easing is on its own unlikely to provide a substantial economic boost has been reported and analyzed at length, including here, and the market probably recognizes the risk. No matter, more than in anticipation of economic lift the market seems to be trading on dollar devaluation, (also associated with QE2). We of course realize, but perhaps turn a blind eye to the fact, that the Fed is not acting in isolation, and that a cheaper dollar necessarily must be cheap in relation to some other currency. Few if any central banks seem nowadays happy to sacrifice theirs for the benefit of ours, and a point will come when the declining dollar will no longer suffice to prop up stocks. When this occurs, we will likely become more focused on fundamentals, and coming on the heels of a “Great Recession” and two years of cost-cutting to the bone, such analysis should lead us to revenues head-on.

With this in mind, we can have a peak at what may lie ahead for revenues and the economy, watching for signals that the early bellwethers of quarterly reporting season have to offer. Let’s take, for example, JP Morgan: On a 15% revenue decline from a period that was to begin with not particularly stellar, the company managed to somehow still increase earnings and still beat analyst estimates. Cutting compensation helped, no doubt, but what helped even more was an (arbitrary) reduction of loan loss reserves… Pause to consider: Is it not a contradiction of perspectives when, on one hand, corporate revenues for a diversified financial organization decline substantially, while on the other hand, the company feels good enough about economic prospects to deem its loan portfolio quality substantially improved? Does anyone see the irony? It’s ironic, isn’t it?

The broader market didn’t get it: Up strongly all day, post-announcement, while JP Morgan shares themselves traded down. Such bumping and grinding and disoriented stuttered-steps are bound to occur in the wee hours, when the group gets all pointless and sloppy. When a stock that is driving the market up concurrently moves in the opposite direction, the party is beginning to get unruly.

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Footnote ahead of earnings

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That the stock market has become a currency market is not an event without consequences. We saw evidence of the phenomenon recently, on a day in which the most fundamental of all fundamental economic news – domestic jobs and prospects thereof – was distinctly bad, and the domestic stock market ignored this while trading up due to dollar devaluation prospects. Considering the international dynamic of the largest corporations – particularly those most heavily represented in the major indices – such market reaction should not be surprising. A weaker dollar results in larger repatriation of overseas profits, (if only as a matter of bookkeeping), more attractive export prices, and a more lucrative buying environment for international investors. That such internationalization of perspectives may lead to an increasing gap between international Wall Street and domestic Main Street was discussed in another article here, but that’s a discussion to revisit much later. More immediately, another earnings season will be upon us, and we should now focus our attention to the consequences of a volatile currency market on soon to be released results.

As the dollar has softened, we should probably expect a positive earnings impact on companies with substantial overseas components, for reasons stated. Regardless of whether overseas product demand has actually increased, all things being equal, the net result of a weak dollar will be to facilitate dollar-profits in relation to what a stronger dollar may have produced. As the Fed, moreover, is indicating additional quantitative easing ahead, the inflow of money to the system will add to dollar devaluation pressures, so that positive earnings guidance by companies with material exposure overseas could be provided with some confidence. Stock traders and their machines will likely pounce on the “information” with excitement, or at the very least this currency market aspect will soften any potential blows, just as it did when poor economic data was recently released.

What such an environment, however, should underscore, is not so much a strong (or relatively less weak) earnings potential for international corporations, but an added element of risk with respect to earnings stability. If what is suggested herein comes to pass, then the future earnings of companies will depend on a continuing friendly currency environment, much in the same way that some had depended on continuing availability of financial leverage. All things being equal, again, the value of the dollar will have to remain at its current level in order for such “leveraged earnings” to be sustained, while earnings growth will at least partly depend on further currency devaluation. Any foreign exchange move to the other direction could lead to magnified negative consequences, and this is a risk that has to be seriously considered in an environment of zero-sum relationships – now entering a state described by participants and observers as a currency war. As is the case with any leverage, volatility in the environment compounds the risk to the sustainability of value, and currency exchange risk may be a particular threat in a market that relies heavily on friendly support.

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The sequence of cause and effect reversed

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We have been conditioned to think of stock price movements occurring in anticipation of economic cycles, of having predictive characteristics. For this reason, economists and other watchers have been baffled by the market rally of the past month, when economic indicators have been fairly consistently pointing to a flat economy at best, or perhaps a looming double-dip recession. To no small extent, the phenomenon has been attributed to talk of quantitative easing (QE2). Notwithstanding the near-term liquidity that such monetary intervention would bring to both the stock market and its indirect influencer, the currency markets, the actual economic lift potential remains dubious to many, including the Fed itself. Observers have thus dismissed QE2 and the market response it has triggered as a misreading of prospects.

But what if this interpretation is the result of our classical education that puts the horse before the cart, whereas we may be entering a new season in which the cart before the horse is the indicated approach? In other words, what if the stock market is not only a predictive device, but also an economic factor that can itself drive economic direction and become self-fulfilling? It may be worth considering if what we are accustomed to think of as the market’s anticipatory relationship with the general economy, can in some cases be turned upside down, or sideways. Could a quantitative easing, thus, become a market manipulation device that, rather than draconian, is a positive influencer?

Because the market is visible to all and does not have to be interpreted like the ISM Survey or some such, it contains a powerful messaging characteristic. When the sub-prime bubble burst in 2008, for example, and the S&P index fell to the mid-600s, this highly visible collapse for many became and economic proxy. The cause and the effect is not always absolute and clear, and the stock market in 2008 may have been as much a catalyst for economic decline as it reflected it. By the same token, a movement in the opposite direction, or a stable market held up even by artificial means, might have led to a different outcome. When so much of our present condition is driven by mood, should the market fall according to economic overtones, this could exacerbate economic stagnation with the soured disposition that the evening news would perpetuate.

Additionally, and even more interesting perhaps this time around, is that the stock market can also influence an economy in more than atmospheric ways. There is now an enormous IPO pipeline, for example, that is waiting to be priced, and which will not be priced to satisfaction under choppy conditions: GM has been waiting and waiting. In the private market, in the meanwhile, venture firms are finally starting to raise funds and make investments again, after the Sequoia RIP scare two years back, and their limited partners may only need another correction to pull in the reins more drastically. These issues and others are concrete. These come with immediate impact.

So, whether one agrees or disagrees with the near- and longer-term repercussions of thus using capital markets as an economic tool, or whether one even considers the case presented to be valid, the market-economy dynamic may warrant a revisiting in this new context. A market is nothing if not a balance of opposing forces, and identifying dichotomies could help to better understand its results. Bulls and bears were only a simple beginning: There are Wall Street and Main Street; inflation and deflation; and now also, there is the sequence of cause and effect. This morning, CNBC presented a confidence survey that showed a mild improvement from the prior month. Other than the stock market rally described, there is really no valid substantiation for improved sentiment.

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