This Accounting Rule Change Could Send Stocks Soaring
Friday, February 6, 2009
by Marc Lichtenfeld, Senior Analyst & Healthcare Specialist, Smart Profits Report
and Martin Denholm, Managing Editor, Smart Profits Report
Dear Smart Profits Report Reader,
598,000 jobs lost in January - the worst in 34 years…
… and just to keep us on our toes, the erratic stock market reacts by zooming higher. This on top of an unsurprising Washington holdup in passing the economic stimulus package, too.
One can only imagine that the market is shrugging off the news because the abysmal figure from the Labor Department didn’t stink up the joint quite as badly as feared. It’s like being thankful when your son escapes injury after taking your car without permission and backing it up through the closed garage door.
But make no mistake… the market will not be able to continue rallying on horrible unemployment numbers, no matter how much worse the expectations are.
There is something out there, however, that could launch stocks sharply higher in the short-term…
Debits And Credits
If thinking about accounting rules puts you to sleep, you’re not alone. But it’s imperative to pay attention to a change in mark-to-market accounting rules that could make stocks as explosive as Christian Bale on a bad day.
Mark-to-market accounting, also known as “fair value accounting,” occurs when companies have to value assets based on their market price. Sounds reasonable, right? However, many financial institutions carry very thinly traded complex derivatives on their books.
And during adversity like today, when these assets become distressed, a fire sale on prices can have adverse effects on a company’s balance sheet and impair its ability to lend, due to capital requirements.
This fair value model has its supporters and opponents…
Pros… Cons… And Fuzzy Math
Arguing against fair value accounting, prominent figures like Steve Forbes and Newt Gingrich say it should be eliminated in order to free up the balance sheets of these financial institutions.
But proponents contend that fair value accounting is the only way for the public to accurately gauge a company’s financial health. Previously, companies estimated the value of the assets themselves.
It’s a valid argument that during a severe downturn, fair value accounting can accelerate the deterioration. As more assets become distressed, companies’ balance sheets worsen along with them.
However, to have companies simply “make up” the value of these assets strikes me as foolish. Sure, they won’t be picking the numbers out of thin air - but they’ll use all kinds of complex formulas and fuzzy math to arrive at the number that they want. There’s a lot of creative accounting that goes on in valuing these assets.
So what’s the point here?
This Sector Could Reap The Rewards Of An Accounting Change
I’m not trying to persuade you one way or the other as to the validity of this accounting rule. I’m simply making you aware that if the rule changes, even temporarily, it should have a profoundly positive impact on stocks.
And one sector in particular should soar - financials.
As my colleague Jim Stanton noted in his “Sector Watch” column on Monday, the financial sector is often a leading indicator for the market. And if that holds true in this case, it would likely take the rest of the market with it.
But you’ll probably need to act fast, as any whiff of change will motivate buyers. So in keeping the issue on your radar, here are some stocks to consider jumping on for short-term trades if this change takes place…
~ Citigroup (NYSE: C)
~ Morgan Stanley (NYSE: MS)
Why? Quite simply, these firms have plenty of toxic assets on their books - and their balance sheets should benefit from the elimination of the rule.
If you’d rather go the ETF route, you could take a look at…
~ SPDR KBW Bank ETF (NYSE: KBE)
~ Merrill Lynch Regional Bank HOLDRs (AMEX: RKH)
~ Financial Select Sector SPDR (NYSE: XLF)
Accounting isn’t usually a very stimulating subject. But keep your eyes and ears open for any change to this rule - if it’s eliminated, you’d be surprised at how exciting accounting can be.
* * * * * * * * * *
So Much For The Ox: A New Year, But No Jobs In China
Fresh from its New Year celebrations, China has now entered the “Year Of The Ox.”
Sadly, that’s in name only with regard to the country’s deteriorating job market, which is anything but strong.
As millions of migrant workers return to their jobsites after the holiday, as many as two million of them are finding that they actually don’t have a job to return to.
In fact, the Chinese government’s Agriculture Ministry announced earlier this week that no sooner had 20 million of the country’s 130 million migrant workers arrived back at their worksites, they promptly had to turn back because there was no work for them. That’s double the amount forecast as recently as December.
There are two main risks with grim news like this…
Jobless, Penniless, And Homeless
First, the low-cost migrant labor market in China makes up a crucial component of the country’s manufacturing sector. And second, if millions of workers travel great distances, only to find themselves out of work, it leaves them not only jobless, but penniless and homeless. Many employers provide housing to their employees, but with factories having shut altogether, or delayed their re-opening, these residences are also shut.
In turn, that could breed a wave of social unrest - a prospect that only heightens as the job market heads downhill. Already, some reports suggest dissension is growing, akin to the protests over jobs seen in Britain and France recently, while the Xinhua news agency forecasts a record year for labor protests and “possibly the toughest year” for growth since the late 1990s.
Can China Spend Its Way Out Of Trouble?
Meantime, the Chinese government is trying to engineer a “comeback” for a slowing economy that “only” grew by 6.8% during the fourth quarter of 2008 and 9% in 2008 overall (cue jealous cries from The West).
Part of that may include a boost to the government’s four trillion yuan ($584 billion) economic stimulus package to pump more money into developing rural areas.
But even that might not be enough. Chinese purchasing managers expect the economic situation to decline further (albeit not as rapidly) - a forecast that the statistics attest to. A survey of 551 companies by the American Chamber of Commerce of South China found that they plan to invest $6.5 billion this year, half the $11 billion it forecast this time last year.
That’s all for today - and for this week. Have a good weekend.
Marc Lichtenfeld & Martin Denholm
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