Tuesday, November 13, 2007

Clearing the Decks

Here’s something no one seems to be commenting on – the impact that Sarbanes-Oxley will have on the reporting of the sub prime and other credit derivative problems lurking on the books.

There are 48 days and counting until the end of 2007, which means that the books will be closed for the year. The significance of this simple fact is this: CEOs have to sign off on their company’s performance and the data contained in the financial statements, including the balance sheet (and off balance sheet) items therein. According to Sarbox, that means they are personally responsible for the results generated.

Now, you tell me: When it comes to potentially hidden credit-related bombs what CEO is going to sign off on a statement of company performance that is not squeaky clean?

Before we are into 1Q08 you can bet that the bean counters and other appropriate company experts will be working extra hours to uncover any and all credit related problems that may still lurk in the shadows. Clearly, no CEO is going to sign a document that puts him/her at greater personal risk than is necessary.

Interestingly, as this information unfolds in the pre-announcement phase and then when the actual reported earnings season gets underway, the timing of the disclosure coincides rather neatly with the expected trough in the US economy that most economists are calling for – first and second quarter of 2008. That is also the time when many of the ARM resets begin to occur in earnest.

Therefore, despite the current angst and worrying, the end of this phase of the credit related crisis is in sight. The US economy will then rejoin the global growth story and fearful memories will fade as liquidity does it magic once again thereby setting the stage for what lies ahead - including the most likely next bubble.

Investment Strategy Implications

In the coming days and weeks, watch for signs that the equity market does not decline on bad news. If that occurs, buy into those moments.

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