EXIT STRATEGY / BARRON´S ( RECOMMENDED READING )

Monday, July 6, 2009

UP AND DOWN WALL STREET

Exit Strategy

By ALAN ABELSON

Wall Street's hottest new buzz-phrase. The monster squeeze on states. Sick job market.

IN CASE YOU'VE BEEN OUT OF TOUCH, SEARCHING for female warriors in the Amazon jungle or engaged in some other worthy pursuit, the new buzz phrase in Wall Street is "exit strategy." Heretofore used primarily to describe politely the urgency of our getting the heck out of some foreign entanglement that we've blundered into, "exit strategy" now has been enthusiastically embraced by financial savants, many of whom are lexically challenged and hence eager to mouth the latest jive.

The exit strategy has also found avid followers among those Nervous Nelly investors who, just because the stock market enjoyed a bang-up second quarter -- with the Dow Jones Industrial Average up 11%, the Standard & Poor's 500 index, 15%, and Nasdaq, 20% -- get all in a lather, fearing another bout of vertigo. Relax, we say. What's to be afraid of? Haven't they heard we're in a new bull market and the trend is your friend?

While exit strategy has not yet reached the quickening popularity among market mavens of "second derivative" (which means hypothetical but bullish), let alone the ad nauseam status attained by "green shoots" and such golden oldies as "Goldilocks economy" and "new paradigm," give it time.

There's lots of chatter now, for example, about whether the Fed is mulling an exit strategy to shed its unseemly balance-sheet bloat, induced by raining dollar bills on the deserving and undeserving alike. That Bernanke & Co. will abandon, however reluctantly, their easy-money mode is a sure bet. Precisely when is hard to predict. But our offhand guess is it'll happen in your lifetime, particularly if you're under 30.

One of the things that strikes us, after observing the sorry episodes necessitating an exit strategy, is that the vast majority of them, whether in war, diplomacy, politics, romantic involvements or finance, could have been avoided by an "entry strategy." But that requires a bit of foresight only arrived at by heavy-duty cognitive labor, which, for the most part, is conspicuously absent from all of those endeavors.

Besides its sudden pride of place in the Street's vocabulary, what got us nattering on this way was the 150-year sentence given to Bernie Madoff. Bernie is a hugely ambitious striver, aiming to be No. 1 in all his undertakings. Anyone can amass a fortune as Warren Buffett did, by buying and selling stocks. But Bernie went Warren one better -- amassing a fortune from the stock market by sedulously not buying a single share.

We haven't the faintest doubt that Bernie suffered profound remorse when he realized that while his fraud was the biggest of its kind in all of history and thus assured him what he prized most -- an indelible prominence in the annals of Wall Street -- his punishment greatly diminished that extraordinary achievement. For his sentence doesn't come close to that meted out to such contemporary swindlers as Norman Schmidt, who drew 330 years, and Sholam Weiss, who got 845 years, and -- this must have really rankled -- for stealing what compared with Bernie's heist was peanuts.

Ah, well, Bernie, if it's any consolation, you can't win 'em all. And look at the bright side: you're only 71, and you know where your next meal is coming from for the next century-and-a-half. That'll give you plenty of time to plan an exit strategy.

REDUCED TO FOUR TRADING sessions to enable Street folk to properly celebrate July Fourth and head to the beaches and the hills, last week encompassed the end of the second quarter (time does fly when investors are having fun). Usually, apart from institutions doing a bit of window dressing (some dare call it manipulation) to put the best face possible on their portfolios to keep the investment masses from getting restive, these truncated weeks when Wall Street goes on holiday are as exciting as watching a cow chew. But the action last week was anything but desultory, mostly because the rest of the world refused to stop spinning and reality refused to take a recess. Stocks started off the third quarter creeping up on Wednesday only to take a big spill on Thursday that was fueled by another awful employment report (details to follow).

No doubt when the cheerleading contingent, whose ranks have swollen with every uptick in stocks, comes back from braving the waves off the Hamptons and smelling the flowers in the countryside, they'll be once again loudly discovering fresh evidence (visible only to their superior vision) that the economy's on the mend. There are signs, though, that Jane and John Doe aren't buying it, for the simple reason that they're hurting so much.

The economic sages likely are too busy tweaking their computer models (you know, the ones that never saw the fiercest postwar recession coming and have been registering recovery ever since) to pay serious heed to the growing financial pickle the states are in, beset by the double whammy of shrinking revenues and spiraling costs while they struggle to balance their budgets as mandated by law. Ordinary people can't blithely ignore the squeeze if for no other reason than it hits them where they live.

Exhibit A is the not-so-golden state of California, with a budget deficit of over $24 billon and counting and a fractious legislature that can't agree on what to do about it. Running dangerously low on cash and credit, the state has resorted to IOUs for the first time since 1992, and temporarily shut down its offices three days a month, placing employees on an abbreviated workweek, increasing the bite from their paychecks this year to 14%.

As David and Jay Levy observe in their latest edition of the Levy Forecast, "The entire state and local government sector, representing about 15% of the economy, is starting a contraction like none other in postwar history." Citing estimates by the National Conference of State Legislatures, they reckon that the states had a combined deficit approaching $102 billon in fiscal '09 and in the new fiscal year will find themselves a cool $121 billion in the red.

And those daunting figures, the Levys sigh, do not count the multitrillion-dollar problem of unfunded future retiree benefits, nor the revenue shortfalls of local governments, including school districts. To close the gaps, states, as California illustrates, are going through conniptions, hacking away at jobs and hours worked. Such measures, the Levys point out, have sorry consequences in the overall economy, and worsen the problems of the still-towering debt load weighing down the consumer.

The bottom line is glum. "The state and local government crisis," they predict, "will worsen, scaring the municipal finance market, creating a divisive national debate on federal aid to states and shaking household confidence in hard-hit areas by forcing painful cuts in basic public services."

But, please, don't tell the cheerleaders.

THE POOR WORKING STIFF. His mother never told him he'd grow up to be a lagging indicator. But, alas, if you credit economists (admittedly always a dangerous thing to do) that's just what he is.

The logic of this designation leaves us bemused. Jobs, the last we looked, were held by men and women. They make up the bulk of what are called consumers. Consumers, in turn, account for roughly 70% of the economy. When a large number of consumers lose their jobs, they don't consume as much and the economy will contract. So how can employment (or the lack thereof) be a lagging indicator?

As the June employment report, released last week, confirmed, the job market remains in the pits. Payrolls were slashed by 467,000 slots last month, bringing the total of people unemployed to 14.7 million. The unemployment rate edged up to 9.5%, the highest level in 26 years. Moreover, the losses would have been worse had the Bureau of Labor Statistics' magical birth-death calculation not conjured up a mythical 185,000 jobs.

To get a truer fix on the woeful condition of the job market, take a gander at table A-12 of the report and, more specifically, at the line devoted to U-6, which includes discouraged job seekers and part-timers who would dearly love to be full-timers. By that gauge, June's unemployment rate weighed in at 16.5%, another new high. And the real number of involuntarily idled workers would rise to an awesome 25 million or so.

As Philippa Dunne and Doug Henwood, proprietors of the Liscio Report, comment ruefully, they can find almost nothing encouraging "buried in the innards" of last month's employment numbers. They note that losses were widespread over the capacious spectrum of industries.

Those lucky workers who managed to hold on to their jobs saw their workweek dip to an all-time low and yearly aggregate hours decline by 7% to the lowest level since the category was added back in 1964. Our savvy duo also remark that had the labor force grown in line with the population, the jobless rate would have risen to 9.6%. Which leads them to wonder "if some serious discouragement is setting in" and "the marginally attached are becoming the formally detached."

And lastly, but scarcely unimportantly, Philippa and Doug observe that forward-looking indicators like temp employment were also "unpromising." And they conclude that while "it's cheering that the rates of decline have slowed from earlier this year," they find nothing to suggest an imminent turnaround.


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