Bottoms Up!

Giving the devil his due, the bottom-up crowd has won this round, as earnings results are not disappointing as economists did for the third quarter. Therefore, in light of the recent market action, it seems more than productive to understand the nature of this important (but not dominant) segment of the market.

Most investors are bottom-up oriented. They buy and sell stocks with a passing reference to the sector and style tilt their portfolios produce. Like many sports teams, portfolios are populated with the best ideas. Sectors and styles are a by-product. Individual company earnings results, performance metrics (such as profit margins, growth rates, etc.), and valuation levels determine the buy/sell/hold decisions made. From that comes the action taken.

This situation is largely due to tradition and training: traditional among individual investors, training among the professional crowd (the CFA program, for example). It is what the financial media obsesses on while providing limited, yet sorely needed, education on what constitutes good portfolio management.

As one of the two essential elements that drive stock prices up or down (the other being financial market liquidity), earnings results can dominate the moment, as they appear to have done thus far this month. When good earnings results motivate investors to act positively, the momos (the real power in today’s market) join the party, as they are indifferent to the reasons that drive investors and are far more interested in an excuse to act. As long as money is abundant (financial market liquidity), the upside bias exists. Which brings us back to earnings results.

As long as companies deliver positive earnings results and financial market liquidity remains ample, the bottom-up crew can move markets (aided and abetted by the momos, of course) to a significant degree. Should earnings falter, however, then the dual impact of declining results and diminution of financial market liquidity (in the form of redemptions and withdrawals) can produce a negative feedback loop to the real economy (Soros’ “reflexivity”). Yet, more importantly, within this investing approach lie the seeds of its own destruction.

Bottom-up investing is aided and abetted by ivy tower fantasies about efficient markets, assisted with high-sounding phrases like “price discovery” and “capital asset pricing models”, and supported by economic methodologies that are anchored in traditional metric analyses. Such traditional economic methodologies do, however, come with two significant blind spots: the inability to forecast with any degree of accuracy and consistency (certainly commensurate with a practice that fancies itself as a “science”) and an inability to do global macro analysis particularly well.

The first point is self evident and saturated with historical fact. For example, one need only look at today’s consumer confidence miss to see just how off the mark these “social scientists” can be. The second point was made most evident in the debacle known as the Great Recession. Moreover, the inability to do global macro well also comes with an inability to incorporate contagion’s speed and source (real and/or financial economy).

This is a big part of how the world works in Wall Street. It is the dynamic reality that exists in the surreal world of finance. It is the state of denial that many who play the investing game occupy. And it is why it is so essential to step back and smell the global macro rose, which right now has a decidedly foul odor to it.

But, hey! “Who cares?”, say the bottom-up boys and girls. "Earnings are good and that’s all that matters to me."

The (Fed) King's Speech

Lionel Logue: [as George "Berty" is lighting up a cigarette] Please don't do that.
King George VI: I'm sorry?
Lionel Logue: I believe sucking smoke into your lungs will kill you.
King George VI: My physicians say it relaxes the throat.
Lionel Logue: They're idiots.
King George VI: They've all been knighted.
Lionel Logue: Makes it official then.

“We have seen increasing evidence that a self sustaining recovery in consumer and business spending may be taking hold.”
Fed Chairman Ben Bernanke
Congressional testimony, March 2011

There are two major issues equity investors are currently struggling with. The first is the obvious one: the price of oil. The second is one that I raised months ago at each and every Market Forecast event (10 of them) that I conducted throughout the US: will the US economy reach what economists call “escape velocity” and achieve a sustainable, private sector-led economic expansion WITHOUT the aid of government stimuli? Apparently, our esteemed Fed chairman has answered that question. Let’s hope he’s right.

Let’s hope that:

• The US consumer is capable of spending beyond his/her means, a fact that becomes that has been made all the more difficult as middle income wages have stagnated for decades, that the ability to borrow is now limited to non revolving (as in autos) credit versus other sources, such as revolving (credit card) and home equity withdrawals (see Monday’s Consumer Credit report for the latest installment of this reality), and that the need to continue to repair their balance sheet (deleverage, a/k/a save more, spend less) is combined with the need to prepare for a world of reduced government support (cuts to Social Security and Medicare, for example) looms on the horizon.
• US based corporations decide it’s time to unleash their nearly $2 trillion cash horde on capex projects in the low growth/high cost US and not in the high growth/low cost emerging markets.
• High growth/low cost emerging market governments allow US based companies in to the detriment of their domestic companies, not to mention their emergent, large, multinational competitors.
• Cut backs at the state and local level don't more than offset a prospective hiring and wage increase binge by US companies.
• The US dollar doesn’t crater to new all-time lows thereby driving up longer-term interest rates.
• The unrest and turmoil in North Africa doesn’t leap frog over the Suez Canal into the oil rich, Western friendly despotic kingdoms of the Middle East thereby driving oil prices to record levels.
• The structure of the markets doesn’t produce a financial crisis courtesy some financially engineered Frankenstein ("It's alive!") product, service, or process that few truly understand.

This partial list of concerns is the tip of the iceberg. The full list is a long one. But that’s what bull markets driven by tons of liquidity and constructive earnings results* are supposed to look past. Or, so it's said.

Investment Strategy Implications

Stock market dogma states that a bull market climbs a wall of worry. However, when that wall has lots of grease on it and given the interconnected, interdependent, rapid transmission nature of our globalized world, any slip can turn into a self-reinforcing downward tumble in a very short period of time.

Hope is not a strategy but in the end it may be what this bull market largely rests on.

* The one truly bright spot, that may have run its course with its cutting, management and technology efficiency benefits. Is there more blood that can be wrung from the cost cutting efficiency stone?

Note: Many of the above points were expressed yesterday when I appeared on foxbusiness.com. To view the interview on my media blog click here.

Dreams of a Cyclical White Knight

And now for some more first order thinking.

At the heart of yesterday’s commentary is the issue of cyclical recoveries morphing into sustainable economic expansions. The argument by the bulls subscribing to this view is that this is precisely what will occur this time as it has every other time before. The virtuous cycle saves the day. This is about as straightforward as it gets. The argument against this thinking is equally straightforward.

When the global macro economic system is hit by an extraordinary event, the post crisis environment is anything but normal and the odds of a cyclical recovery resolving a structural crisis are very long. What is then needed is a structural solution to a structural problem. Examples of this thinking abound (not that the cyclical bulls are listening), with today’s commentary in the FT by Martin Wolf among the most cogent.

The topic of Martin’s commentary may be the emerging currency war with a particular focus on China. The essence of Martin’s commentary is, however, the more important point – structural problems require structural solutions, which in a global economy can only be solved via cooperation between the major global players. Yet, cooperation between the major global players requires leadership. Since the logical country in a position to exhibit that leadership, the US, has as its head a political manager and not a leader, the odds of someone taking the lead toward the necessary cooperative environment for structural change are very long indeed.

The Post Crisis Environment

Crises occur mainly due to structural (systemic) problems. The post crisis environment that ensues is one that rarely resolves itself via the cyclical solution. Yes, cyclical rebounds do improve things for a while but they do not get to the heart of the matter. The structural problems remain and will overwhelm the relatively meager energy of a cyclical bounce. It’s like trying to treat a patient with a life threatening disease with antibiotics. It just doesn’t work.

To use the stock market analogy in the current environment: cyclical bull markets within secular bear markets do not change the reality that the equities are in a secular bear market. Accordingly, cyclical recoveries within a structural (secular) change environment will not resolve the systemic issues at hand.

The bullish rejoinder to this is the muddle-through solution: Things are never so neat and tidy. Stuff happens, things are messy. But, fear not, we will find a way out of this mess. We always have and will do so again. This time is not different.

However, as I argued yesterday, such thinking concludes that this time IS different, for the norm in a post crisis environment is for extraordinary measures to be exerted, which includes fundamental changes in the rules of the game. Therefore, this time is not different as crises do occur and the subsequent environment requiring fundamental change is the norm.

Who will be right? The cyclical-recovery-saves-the-day crowd or the we-need-to-address-the-structural-problems club? Time will tell, which I suspect will be sooner than most think. One thing is for sure, however, someone is going to be real right and the other will be real wrong.

Investment Strategy Implications

My money is with the structural problem club. However, the cyclical dreamers are in control right now. Therefore, as an investor and investment strategist, I cannot act aggressively until the technical analysis signs that the market is ready to embrace the more worrisome view of my club. (Think, the recent vintage tech and real estate bubbles.)

Accordingly, before shifting from the currently cautiously bullish (60 to 90% in equities) posture to neutral (40 to 60% in equities) to outright bearish (<40%) clear technical analysis signs, most notably external and internal divergences, must be evident. At present, as noted last week only the internal divergences are. Therefore, cautiously bullish (the equivalent of driving with one foot on the brake) remains the advisable strategy.

As history teaches us all too well: delusional thinking rooted in old school dogmas can maintain its grip for a very long time.

This Time IS Different

The bulls (not the bears) would have you believe that this time is different.

The root of this view in anchored in the dogma that the cyclical recovery cures all ills as follows:

The cyclical recovery evolves as increased corporate spending on wages and new hires which, along with an increase in emerging economies’ consumer spending, result in a consumer led demand driven sustainable cyclical expansion. Corporate profits rise further enabling the virtuous circle to become engaged.

The sustainable cyclical expansion then helps to alleviate the structural risks to the global economy – e.g. current account imbalances – thereby enabling the financial sector to recover further and move the global economy off government life support.

The financial markets respond with a move more toward normality as rates rise, the dollar stabilizes, gold loses its luster, and equity valuation levels return to above average (>15 times). The combination of higher corporate profits and above average P/E levels drives stock prices back to record highs, which for the S&P 500 means 1548 (18 x $86).

An era of growth and prosperity returns thereby proving that this time is not different; that there will be no new normal (i.e. below average growth and profitability).

Sounds good, doesn’t it? Even plausible, provided one thing – conventional thinking in unconventional times requires a belief that this time IS different.

The Burden of Proof

The bulls would have everyone believe that the burden of proof that this time is different falls on those who say what was no longer works (the old normal) and that the future is a place of great uncertainty (the new normal) with the road ahead a most bumpy one. There’s one problem with this thinking – evolutionary processes to new normals are normal. A purging of the old always occurs and it always leads to a new normal, whatever that new normal may be.

Extrapolating the recent past into the future often becomes a substitute for first order thinking. Be it fighting the last war or blindly accepting corporate earnings guidance, embedded interests conspire to preserve the status quo, which facilitates a blindness to change. And it is change that is normal, not what-worked-before-will-work-again-indefinitely thinking, made all the more illogical given the highly dynamic complex global macro environment the world finds itself in.

In evolution, those that are about to become extinct are the last to notice. The same is true in the social sciences of economics and the markets, where old rules in changed times demand the view that this time is different.

We Are BP

“We are about to embark on a momentous experiment to discover which of the two stories about the economy is true. If, in fact, fiscal consolidation proves to be the royal road to recovery and fast growth then we might as well bury Keynes once and for all. If however, the financial markets and their political fuglemen turn out to be as “super-asinine” as Keynes thought they were, then the challenge that financial power poses to good government has to be squarely faced.”
Lord Robert Skidelsky, FT, “Once again we must ask: ‘Who governs?’”, June 15, 2010

The transitional nature of this stock market fits perfectly with the transitional nature of the global economy – are we headed for the virtuous circle of sustained economic growth or will the decision to withdraw fiscal stimulus advocated by the G20 members result in a double dip (or worse)? The early answers to this question will not be found in the present but in the near future – specifically the third quarter of this year.

Once we get the at-to-slightly-above-consensus 2Q10 earnings results out of the way, most of the focus will shift to the third quarter. Early into the third quarter, macro economic reports will provide an advance notice of what lies ahead for 3Q10 earnings. If the traditionally trained economists are correct, 3Q10 economic results should present no problem and come in at or above consensus expectations thereby ensuring that 3Q10 earnings results will meet the current optimistic projections.

If, however, third quarter macro economic data issued week after week produce below consensus results, then 3Q10 earnings results are nearly certain to come under expectations. Then the fun begins.

Stock Market Signals

All this would coincide with stock market action that will reflect a resolution of the sideways performance exhibited by virtually all indices since the fall of last year. This resolution will present itself in the all-important Mega Trend. If the Mega Trend* reasserts itself with price moving back above both key moving averages AND in the process reverses the recent bearish Mega Trend signals from Europe, then the trading range of the past 8 months has been a consolidation range, the bull market is back in gear, and the real economy will likely not suffer a double dip (or worse).

If, however, the Mega Trend in the US and Asia follows the lead of Europe and produces a bearish reversal signal, then it’s game over – the real economy outcome will likely be something far worse than a double dip.

Investment Strategy Implications

Going into the third quarter, investors who subscribe to the above have two choices: Bold or Cautious.

Bold would recommend a 100% exposure to equities. Cautious would suggest a 60 to 80% equity exposure. While both approaches stand at the ready to shift gears should a bearish outcome become evident, I believe there are two advantages to choosing the cautious stance.

First, any near term decline (i.e., a move to the lower end of the trading range, which is 1000 to 1050 in the S&P 500) would generate a negative return but positive alpha, while any near term advance (i.e., a move to the top end of the trading range, which is 1150 to 1220 in the S&P 500) would produce a positive return but negative alpha. A form of portfolio insurance, if you will. Secondly, and perhaps most importantly, a cautious approach keeps the mind focused on the worse case scenario and will help facilitate rapid action once the below consensus economic readings start filtering in and the bearish Mega Trend signals are generated.

Chill Until

Stocks do not trade in a range indefinitely. A resolution to the upside would say that the trading range was a consolidation, that the bull market will resume, that global markets that had been weak were temporary, that the economic handoff of government spending to private sector sustainable growth has been successful, that the virtuous circle has taken hold, and that earnings and other key inputs into the valuation process will be better tomorrow than they are today.

Alternatively, a resolution to the downside would declare that the trading range was a distributional top, that global markets that had been weak were a warning sign, that the economic handoff of government spending to private sector sustainable growth has not fully occurred, that the virtuous circle has not fully taken hold, and that earnings and other key inputs into the valuation process point toward a tomorrow that will be worse (I would argue far worse) than they are today.

Alfred E. Neuman Would Be Proud

If there is anything to be learned from the recent crises it is that incremental thinking to rapidly deteriorating situations produce catastrophic results. Here’s a partial list:

• It’s only a subprime mortgage problem
• The banking crisis is contained to the financial sector
• Greece is a very small part of the European economy
• It’s just an oil spill, a leak

With virtually no margin for error this time around (as in extremely limited government flexibility), any economic deceleration or decline could snowball rather quickly. The wrong thing at precisely the wrong time. Partying like it's 1937.

All That Jazz

The quote from Lord Skidelsky above says it well - we are about to embark on a grand experiment, we will improvise as we go along, we are confident in our experts, we have faith in our meritocracy, we are BP.

Will this work? We will find out soon enough.

*Use the search function at the top left of this page for prior blog postings on the Mega Trend.

We’ve Seen This Movie Before

The dramatic news on Friday (re Goldman Sachs) has a more narrow impact (directly on Financials) and a far more limited impact on the broad market as the economic recovery and its sustainability are significantly more important to equity prices overall.

The limited broad market impact would be for Financials to begin to struggle and potentially produce a negative contribution to higher prices. However, the likely offset is a rotation away from Financials and into other sectors where less governmental activism exists. This is similar to what occurred with the Healthcare sector, as the debate became law. Healthcare stocks may have underperformed but the overall bull market remained intact. The same is very likely to occur going forward re Financials and the broad market.

Concerns re an activist government (greater regulation, lower profit margins) appear to be somewhat overblown. The Obama administration's axiom – “Don’t let the perfect be the enemy of the good” – demonstrates both a pragmatic approach to issues and no intention of destroying whole industries and the companies within, the histrionics of the right wing opposition notwithstanding. The price that is being asked to be paid (in the form of greater/tighter/smarter regulation) appears to be a very reasonable one given the economic debacle that succeeded the more laissez-faire approach to regulation.

What may be some concern to investors is the masterful manner in which the Obama administration has finessed their opposition. In a series of events that can only be viewed a classic Clintonian, consider what occurred the past week:

• On Wednesday (April 15, 2010), President Obama meets with congressional leaders at the White House to discuss financial regulatory reform.
• Senate Republican minority leader Mitch McConnell (providing an outstanding example of Pavlovian behavior) steps out of the meeting (fresh from his recent sojourn to the titans of Wall Street) to declare that President Obama is on the wrong side of this issue.
• On Friday, the Securities and Exchange Commission charges Goldman Sachs with investor fraud.

At this point, someone needs to hand Senator McConnell a towel to wipe the egg off his face.

This week, more bank earnings results will be reported, including those from none other than Goldman Sachs (Tuesday, April 20th). The results are sure to further inflame the public outcry re bank bailouts and buttress the efforts of the Obama administration and the Democrats to push through financial regulatory reform.

The consequences of a victory in financial regulatory reform will have repercussions in this fall’s midterm elections. Moreover, it is the manner in which Obama handled the Republicans this time around that is yet to be fully digested by most investors (think Bill Clinton and his famous triangulation strategy). It does appear that the Obama administration (and President Obama, in particular) have relocated their political voice and have combined that with a governing style that needs to better appreciated by investors.

Investment Strategy Implications

Right now, what matters more to equities is the global cyclical recovery. The challenge will be whether the economic handoff (from government spending to sustainable private sector growth) can truly occur. That is a question that still remains to be answered. Despite the solid earnings results of 4Q09 and thus far from 1Q10, it is hard to determine whether growth can be sustained without the life support mechanisms put in place by governments around the world. And the growth in debt, the extraordinary and inventive governmental actions (quantitative easing, for example) and the generous amounts of liquidity cannot go on indefinitely.

The longer-term structural problems (e.g. debt levels, consumer demand in emerging economies, imbalanced domestic growth policies in key emerging economies (notably China), the currency straightjacket on weak economies within the Eurozone, among others) along with the aforementioned Obama’s emergent political skill wait in the wings and may become the rationale for the long overdue market correction. These fault lines are to be monitored closely for signs that they will become the focal point for investors. This is where market intelligence earns it pay*.

In the meantime, the excess liquidity and encouraging cyclical growth remain center stage for most investors. A clear case of the cyclical over the secular. Accordingly, there is little reason for investors to move to the sidelines and adopt anything more than a cautiously bullish position. There will come a time for a more aggressively conservative view. That time does not appear to be now.

*The absence of traditional investors is also a worrisome sign as trading continues to be dominated by the fast money crowd. More on this in a future posting.

Rising Long-term Interest Rates + China + Protectionism = Stock Market Correction

In the coming weeks the din from earnings season should provide the perfect cover for what may turn out to be the single most important risk to equities: rising interest rates.

Good results (at or above consensus) are virtually baked into the earnings season cake. Yet, it is the risk from a rising long-term interest rate environment that is poised to function as the technical analysis catalyst for a meaningful stock market correction.

Should long-term rates rise (as in above 4% in the 10 year US Treasury), there will be two factors at work that could turn rising long-term rates into the catalyst for the long overdue (and healthy) stock market correction:

1 – The direct hit to valuation models via an increase in the discount rate
2 – The technical analysis hoopla around the completion of a multi year head and shoulders bottom in the 10 year US Treasury rate (see chart)

Should long-term rates rise, the usual suspects would be the threat of inflation and the mountain debt to be issued for the foreseeable future. What many investors may miss, however, is the geopolitical collision between “American pragmatism”*, an emboldened Democratic Party and assertive President Obama, and China that results in a diminished purchase of long-term US debt and a concurrent rise in the rate. Here’s how this may turn out:

In just 217 days, voters in the US will head to the polls for the all-important mid term elections. Fresh off their healthcare bill victory, President Obama and the Democrats are feeling their oats, exemplified by Obama’s “Go for it” taunt to Republicans and his recess appointments just announced. Bye bye bi-partisanship, hello hardball politics.

To help stoke the newfound Democratic machismo will be the jobs picture. It is not advisable for investors to let this Friday’s good jobs number (if they occur) distract from the reality that global macro forces (be it globalization and the labor arbitrage or protectionism and diminished global economic growth) are likely to produce a sub par jobs growth environment in the US once again. Such an outcome in a highly political year will almost certainly produce assertive actions by the US focused squarely at the number one villain in this evolving protectionist drama – China.

So, what are the Chinese leaders likely to do if US rhetoric elevates to the point of action similar to what was noted in a recent Economist magazine commentary (“Tricky Dick and the Dollar”)? Take like the Germans did back then? I doubt it.

As Dr. Ian Bremmer (Eurasia Group) so astutely noted in yesterday’s FT article commentary (“China knows the time for lying low has ended”), the moment for just a touch of Chinese muscle flexing appears to be at hand. Moreover, the seemingly disconnected actions re Google and Rio Tinto are more likely part of the overall move (“state capitalism”**) toward a more assertive seat at the global table than a few isolated instances of Chinese governmental activism.

Yet, all pale in comparison to the one instrument of real leverage that China has that, with prudence, can be exercised against the US – its capital. China buys less US debt, diversifies away into other assets, and chooses to assist its own domestic growth needs.

On this last point, with its stimulus money all but fully spent and the need to maintain a high single digit growth rate (to avoid social unrest), China’s leaders can accomplish two goals with one act: aid and abet its domestic growth needs and demonstrate to the US that it can, and will, exercise some of its economic muscle via a diminished US debt purchasing. Weaker demand + greater supply is usually the prescription for lower prices and higher rates.

Investment Strategy Implications

Rising long-term rates cut across all markets and economic sectors. In the coming weeks, should stocks fail to capitalize on a near certain good earnings season the technical analysis stage will be set for the catalyst to produce a meaningful correction in equities. Rising long-term rates will more than fit that bill.

*Listen to my recent podcast interview with Dr. George Friedman on this topic.
**Dr. Bremmer’s soon to be published book, “The End of the Free Market”

V Shaped Rally ≠ V Shaped Recovery

Yesterday’s posted interview with David Malpass brings into sharp focus a key aspect of the US economic recovery that far too few investors are tuned into. Specifically, the underappreciated dynamic that second, third, and lower tier companies (the backbone of employment growth in the US) may not deliver the much anticipated above consensus earnings results this and future quarters ahead. Moreover, as the backbone of employment growth, weakness in second, third, and lower tier companies act as a depressant on wages, hours worked, and consumer sentiment. Therefore, how the US (and global economy) will reach a sustainable recovery without the US consumer is a riddle wrapped in an enigma.

Lacking a large exposure to global markets (where the growth is and where the weak US dollar helps deliver strong short term results), the SMIDS (small and mid cap companies) on down are vulnerable to disappointing investors with at or below consensus earnings results next month. In this regard, David points out in the interview that above consensus earnings results this coming 3Q09 for large and mega cap multi nationals may come to pass via pricing power pressures on all companies offset by volume growth courtesy a cannibalization of the units growth to lower tier companies.

(As a reminder, 2Q09 bottom line results surprised to the upside thanks to cost cutting, as top line growth was largely in line with expectations. In the current quarter ending next week, expectations are for above consensus earnings results produced by top line growth that surprises to the upside (with cost cutting is largely done). With the US economy still on its knees, it is hard to see how US domestic top line growth (revenues = price x units sold) can surprise to the upside. How this happens for companies that will not benefit from global markets (and a weak dollar) is a mystery soon to be revealed.)

Investment Strategy Implications

In a liquidity driven stock market, all logic goes out the window – for a while. Justifications for over valued markets abound. And buy high to sell higher becomes the music that all performance based investors must dance to. Phrases like “melt up”, thanks to expectations that the $3.5 trillion sitting in near zero percent money market funds will be forced into equities, is the support rendered for P/E ratios that warrant above average (i.e. 15 times) levels. Sound familiar?

In such times, a prudent investor is a contrarian investor. Momentum driven/fast money “investors” awaiting sideline money to sell to on the basis of melt ups and a sustainable global economic recovery rooted in a deleveraging US consumer may turn out to be a fantasy bubble about to burst.

The 3 Phases of this Bull Market

The stock market rally since early March appears to have three distinct phases to it.

The first phase was the backing off from the economic abyss. The second phase was a bounce to fair value normalcy. The third phase (the one we are in now) is what I would call the return to business as usual phase (or “Recession. What recession?).

From where I sit, the first two phases were justified on many levels. Both phases featured massive amounts of government intervention combined with strong technicals to produce a rally to fair value. The elimination of the tail risk of the Great Depression II was followed by the above consensus macro economic readings (my MERI indicator), which was reinforced by the above consensus earnings results of 2Q09. Stocks rose to a reasonable fair value. So far, so good.

Unfortunately, at this point the seeds of questionable earlier decisions began to bear fruit. (Now, this going to sound very libertarian, so here goes.) Instead of pursuing the necessary cleansing process that all excesses produce, the Obama administration (which includes the US Treasury and the “independent” Federal Reserve) opted for a massive debt transference from the private to the public sector with the hope that time will heal all wounds. Along with this decision to socialize the bad behavior of the private sector most responsible for the crisis, the financial services industry, the Obama administration supported its core structure built on the laissez-faire era of the past two decades, accepting the largely unsubstantiated argument that financial innovation is a vital and necessary good for the economy.

With the government’s tacit support of the status quo, the investment mood shifted from fear and concern to hope and then enthusiasm.

The evidence of this mood shift back to the animal spirits days of yore came from a logical source – the financial services industry, the very sector of the global economy that provided the financial innovation grease to the out of control freight train of credit. And what better symbolic locomotive than Goldman Sachs, whose earnings report of July 14th whistled the bad old days were back in action. At this point, the Obama administration swung into action – with silence.

With its absence of outrage, the increasingly politically tone deaf Obama administration sent the public policy signal that its okay to bring the world economy to its knees, its okay to get bailed out with taxpayer money, its okay to shrink the competitive landscape (via Bear and Lehman’s demise), and its okay to return to the way things were – big profits and in your face fat bonuses.

The product of this wink and nod to Wall Street was the backlash at town hall meetings, which were as much about fairness as they were about healthcare reform concerns, a paranoid view of government, and a reactionary view of what constitutes being an American. It also produced an enthusiasm for stocks and an implied return to the bad old days.

Investment Strategy Implications

When you combine all these factors with the massive amount of investment capital ($3.5 trillion) still sitting in the near zero interest rate money market sidelines, the rising belief among many institutional investors that P/Es above their historical average are justified in the current low inflation environment, and the fledgling confidence that the global economy is on the mend* (along with the blind faith that the economic data from China is real), it is understandable how valuation levels could get to where they are today – stretched.

The investment question then becomes, “Is this a solid enough foundation upon which sustainable bull markets are built?” I have my doubts.

*I suggest reading Nouriel Roubini's comments in yesterday's FT.

The End User Dilemma

Back on August 3rd subscribers to my weekly newsletter - Sectors and Styles Strategy Report - read the following:

"China may become the bigger fly in the bullish ointment. Unlike the US, China has spent all of its stimulus package money not on consumer demand related areas (where it is most needed) but on more infrastructure projects. Since the US consumer is and will remain in balance sheet repair mode for a while and developed economy consumers (Europe and Japan) reluctant and/or unable to pick up the slack, end user (consumer) demand must materialize from emerging economies. With savings rates very high in China and other developing economies, expectations of V-shaped global economy recovery of a sustainable nature (meaning balanced and asset bubble free) seem fairly unlikely.

Therefore, a close eye should be kept on China and the very real prospect that a bubble burst may occur in that country. Should such an event occur, the global growth story becomes highly suspect, and equity values based on a global V-shaped recovery and expansion very problematic."

At the end of the day, somebody has got to buy something from someone else. The government may be the lender of last resort but it is not the buyer of last resort. That title belongs you and me - the consumer. And, despite its best Keynesian wishes, the prospect of demand being a guaranteed result of fiscal stimuli remains an unresolved mystery. Therefore, as helpful as next year's conveniently politically-timed US stimulus package will be, it cannot be, nor should be, counted on as lifting the world economy out of its end user dilemma. Moreover, government schemes like "cash for clunkers" get you only so far. They're like a life preserver keeping one's economic head just above the water, and nothing more.

Investment Strategy Implications

When stocks moved away from the abyss a certain sense of relief was taken to a modestly enthusiastic extreme. The more optimistic drank the valuation kool-aid of born again bullish investment strategists. "The more things change, the more they remain the same" became the mantra as business as usual replaced the panic-driven mindset - business most unusual.

With the past few days of market decline, perhaps reality will begin to sink into the valuation equation. Hopefully (but not likely), the vital focus on what is necessary for a sustainable global economic recovery will take center stage. And with it a concentrated effort to appreciate the end user dilemma.

Imagine This

The above consensus earnings results produced thus far – 109 companies in the S&P 500 (29% of market cap) 10.3% above estimates* – are doing their thing and moving the fence sitters off the fence. No doubt some of the $3.5 trillion sitting in near zero interest rate money market funds is finding its way into equities. In the process, an overbought stock market gets even more overbought – moving right into the S&P 500 resistance zone of 950 – 1000.

As investors reacquaint themselves with their animal spirits, let’s do something constructive and take a moment to assess the investment significance of the aforementioned 10.3% above estimates fact.

Coming into this week, 2Q09 operating earnings estimates for the S&P 500 were around $14 – annualized to be $56, right in the zone of the consensus number for the full year. Well, if the actual results are coming in at 10% higher, then $14 becomes something closer to $15.50, which pushes the annualized number to approximately $62. Accordingly, investors might want to consider the following:

If companies can produce results that are 10% above estimates in the dismal and economically stressed second quarter of this year, what are they likely to do as the global economy continues to make progress toward stabilization and growth? Moreover, what are the likely corporate results for 2010 when the bulk of the US fiscal stimulus package (some $700 billion) kicks in?

Under such conditions, it is conceivable that the $75 S&P 500 operating earnings estimated by the folks over at Goldman (noted in my Tuesday blog posting) may actually be more than a touch on the low side!

Investment Strategy Implications

Stocks are extremely overbought and a move below 900 for the S&P 500 (versus a surge above 1000) is still the higher probability at this time. However, it is advisable that investors understand and respect the potential of a period of explosive earnings from now through the end of 2010.

While much can happen between now and then, the results for 2Q09 produced thus far are providing the evidence of such a scenario – one that is not on the radar screen of most investors, analysts, and investment strategists.

*Sam Stovall, S&P, July 22, 2009

When Goldman Talks, Investors Listen

For the past two months, I have made the argument that above consensus macro economic data would lead to above consensus earnings results and that investors would see the evidence of this as 2Q09 earnings season got underway. Based on the reports issued thus far, this argument has won the day as above consensus earnings results have matched the above consensus macro economic reports preceding them. Accordingly, stocks responded.

The second part of my argument was that such positive data would eventually encourage bottom up analysts (along with many investment strategists and top down economists) to reassess their more cautionary views and begin to raise their full year earnings expectations for this and next year. This, too, has begun to occur – none more significantly than from the investment strategy folks over at Goldman.

In a research report published yesterday, the Goldman strategists raised their estimates of S&P 500 operating earnings for this and next year - from $40 to $52 and from $63 to $75, for 2009 and 2010, respectively. In the process, the group estimated the target fair value for the S&P 500 at 1060 – ten points above my best guesstimate for the year (as reported in the Wall Street Journal on December 30, 2008) and my more evolved view of the same number based on the simple math of the historical average P/E of 15 times a mid 2010 estimate of $70 = 1050. As John McLane (“Die Hard”) might say, “Welcome to the party, pal”.

With Goldman in tow and many fence-sitting traditional money managers and individual investors being forced to reconsider the wisdom of leaving $3.5 trillion in money market funds earning 0.1%, the more meaningful investment strategy question is “Where are we in the stock market cycle?”

Investment Strategy Implications

As expressed in this week’s research report to subscribers, stocks are clearly in extreme overbought territory at the top end of the range. A completed bottom has not occurred. Therefore, stagnation (at best) or a pullback (most likely) appears to be in the very short-term offing for stocks.

That said, each week provides more evidence that the global economy has moved further away from the economic abyss of early March. Now that monetary stimulus and creative governmental action has done its work, the bulk of the fiscal stimulus package (conveniently timed for the 2010 election cycle) will provide the needed power to move the economic needle from stabilization to growth.

Aided by the global growth story (from emerging economies) as well as the likely positive forces of the wealth effect (from higher financial asset values), corporations, having demonstrated their ability to manage solid results in times deep economic distress, should be able to generate very satisfactory earnings results in an overall improving global economic climate - including a modest contribution from the US consumer.

So, where are we in the stock market cycle?

Stocks appear to be well into a transitional phase – one in which sector (style, country, and regional) rotation will (must?) produce the new leadership necessary for a new bull market to sustain itself to 1050 and beyond. The rotation to new leadership coupled with a completed bottom are the stock market signs most worthy of investor attention.

2Q09 Earnings Season: So Far, So Good…

…but still too early to ring the bullish bell.

As earnings season begins in earnest and will soon kick into high gear, the fundamental valuation proof for equity prices’ faith (since early March) in an improved corporate profitability environment is the central issue at hand for investors. To justify current prices, second quarter earnings results MUST demonstrate that companies can turn in profits above consensus earnings expectations in an overall weak economic environment.

If 2Q09 results come in above consensus estimates (which are around $14 operating earnings for the S&P 500 - see table to your left), then stocks have a solid leg to stand on from which higher prices can follow as the second half of the year unfolds. Such a performance would signal that companies are able to produce sound earnings growth and profitability from the global economy while developed economies, such as the US, struggle with recessions followed by below potential growth.

Operating efficiencies, enhanced by recessionary-induced cost cutting, coupled with exposure to developing economies (which is where the global growth is and will be for the foreseeable future) are the ingredients for the potential of above consensus earnings results.

Conversely, should the numbers in the quarter just ended come in at or below consensus expectations, then concerns re valuation are justifiable. The valuation math in the near term is therefore not encouraging for the bullish case. To illustrate, take a moment to review the above table from this week’s “Sectors and Styles Strategy Report”.

The operating estimates for the S&P 500 for 2009 are in the mid $50 range. With the index at 900, that produces a 16.4 times P/E. Given the fact that the historical P/E for the S&P 500 in normal times is 15, it is hard to get overly enthusiastic for stocks with an above average P/E in less than normal times - which then brings into play the economic weeds that seem to be flourishing among the so-called green shoots.

Investment Strategy Implications

If companies cannot produce above consensus results (via global growth and operating efficiencies) and given the fragile state of the US economy, the suggestion is that the economic weeds that may strangle the US may also inhibit corporate growth and profitability such that earnings results will not justify even an average P/E.

The earnings results issued from several high profile names is, thus far, encouraging. However, as is the case with the technical analysis of stocks and the incomplete bottoming process, investors are well served to see how this plays out over the coming weeks as the earnings season provides more clarity on corporate profitability and the valuation justification for higher stock prices.

When To Ring The Bullish Bell

Driven largely by short covering and a portion of the mountain of cash sitting on the sidelines, stocks have been on a tear since the beginning of March. Many investors have, in the process, bought into the idea of the reflation trade as sectors and countries associated with it (e.g. emerging markets, basic materials) have led the parade thus far*. In the process, valuation levels have become quite stretched on the concern that the next 12 months will produce sub par earnings that do not justify currently lofty P/Es.

For the bears, there is high skepticism that S&P 500 operating earnings will reach a $70 number, which would justify not just where the market is today but be supportive of a run above 1000 (S&P 500). The bulls, on the other hand, argue that corporate profits are on the cusp of a major rebound mainly due to recession-necessitated cost cutting. Accordingly, any economic rebound in our globalized economy will produce the $70 number – and then some. Who will be right?

To gain insight into who will win this fundamental analysis debate, a peek at the technical analysis side of the equation can be most enlightening.

Convergence

Many of the technical analysis patterns and indicators that I follow are flashing very constructive longer-term signals. Mega Trend bullish reversals are on the horizon for just about every index tracked**, along with chart patterns that bear more than a glancing resemblance to head and shoulder reversals.

On a short and near term basis, however, equities are faltering as momentum – the lifeblood of near term market power – is eroding (see second and third indicators in the above chart). On the surface, the fundamental analysis debate appears to playing out in the technical analysis space as well – longer-term things look promising, short and near term not so much. So, where’s the enlightenment?

The missing ingredient is the completed bottom – that point at which stocks have built a sustainable base from which higher prices have a greater chance of becoming an actuality.

Such a bottom has been formed in leadership areas, such as emerging markets (see above chart). Breaks above previous tops formed in multi month trading ranges signal a (mostly) completed bottom. This is not quite the case, however, with developed economy markets, as they have not made such a move. Yet, as constructive as the emerging markets patterns are, only when a mega trend reversal has occurred (which looks like it needs only a few more weeks of positive trading action) can the bell be rung.

Investment Strategy Implications

Old school market technicians will tell you that it is always better to wait until a major pattern has been completed and give up x% of the early move just to be sure that you are on the right side of the trade. Given the fluid nature of the real economy environment, this piece of advice will produce more than its value in peace of mind.

The bullish bell looks like it only needs a few more weeks of positive action. Then again, the Cavs were a slam dunk to make it to the NBA finals.

And Now, Another Soapbox Moment

By blending both fundamental and technical analysis, an investor can see how market participants are interpreting the fundamental stories in the real economy. This occurs on both a macro and micro level, with sectors and industries reflecting the prospects on an individual company level. This also involves Soros’ reflexivity, the feedback loop from the markets to the real economy in which changes in market values help produce the very outcomes they measure.

Fundamental analysis tells you what should be. Technical analysis tells you what is.

*While the stats do show Financials as having the sharpest rally since the early March lows, it is arguable that the profound changes the sector will undergo (to profitability and growth) does not auger for a leadership role on a sustainable basis. Therefore, the powerful rally come from a deep oversold condition that will likely dissolve into mediocrity once the bull phase gets underway in earnest.

**Price above moving averages, 50 day above 200 day, both 50 and 200 day upwardly sloped. See chart above for an example, as well as numerous previous blog postings.

How to Beat the Market WITHOUT Even/Overweighting Financials

The stock market parade in the US has been led by Financials (see first chart). As a result, many investors with well-diversified portfolios may have struggled to produce alpha since the bull rally began in early March, especially if they were underweight Financials - as many no doubt were. In the process of the rally and in an effort not to fall too far beyond in relative performance, these same underweight Financials investors have been forced to plunge headlong into that sector to try and keep pace.

For investors (as opposed to traders), part of the problem with even or overweighting Financials is the high degree of uncertainty facing the sector. With the US government forging ahead with new legislation and regulation designed to steer the financial services industry toward a more managed future (see recent articles on the credit card legislation, executive pay caps, mortgage regulators, and Gillian Tett’s (Financial Times) excellent article on derivatives) no one can confidently predict the future shape of the sector, let alone its sustainable growth and profitability. Therefore, what investments should/could the well-diversified investor consider that can generate alpha AND avoid the issues and uncertainty even/overweighting Financials bring?

One approach would be to increase the equity exposure in those areas where sustainable growth and profitability appears to be more assured AND will benefit from themes that will likely play out for many years to come. Two such areas are emerging markets and global infrastructure.

As the second chart shows, while not matching Financials in the current rally, having a sufficient amount of money in several attractive emerging markets (EEM, EWZ, FXI) and global infrastructure sectors (IGF, PHO), as well putting some funds in the higher beta small cap growth area (IJT), a well diversified portfolio can produce alpha while simultaneously reducing the aggregate beta in a portfolio AND avoid investing in a sector (Financials) that is fraught with long-term uncertainty. Moreover, by doing so, less money is allocated to the underperforming sectors that drag down the aggregate portfolio performance (see first chart, again).

And Now, For Another Soapbox Moment

For well-diversified portfolios with a longer-term time horizon, it's a relative performance game. This is what "diversification with a tilt" portfolio strategy is all about. The underlying assumption is that stocks have a longer-term upward bias and investors should exercise sound asset allocation and modified market timing principles (along with a healthy dose of patience) to achieve alpha. If this stocks-have-an-upward-bias assumption is correct, even a modest 2% per year outperformance will produce exceptional long-term results.

Note: Walking the talk is what you see in the second chart as it represents most of the larger holdings in a small fund run my firm and in the Model Growth Portfolio, both of which have year to date alpha of 293 and 484 basis points, respectively. Needless to say, past performance is not a guarantee of future results.

Welcome to the Emergent Emerging Markets Century

Okay, maybe it’s more than a tad premature to call a good couple of years the start of a century of exceptional economic performance. Nevertheless, if there is one place, from both an economic and investment basis, where investors are well advised to have an above average investment weighting it’s the emerging markets. The following presents a few core elements, both fundamental and technical analysis, which provide a hint as to why having such an exposure is prudent.

From a fundamental valuation perspective, EEM compares quite favorably to the developed economies on both a growth, diversification, and valuation level. As the first table shows, the mix of EEM (emerging markets ETF) is substantially different than that of either the S&P 500 and the EFA. What may be surprising are the large exposure to Info Tech and the relatively low exposure to Industrials. You can also see the favorable comparisons in P/E with beta where you would expect it to be.













From an economic growth perspective, the IMF chart that follows makes it abundantly clear that economic growth over the next few years resides in developing and not developed (advanced) economies.












From a technical analysis perspective, the above positives for emerging markets are reflected in the following charts.

The first chart shows the solid upside breakout from a significantly improving base that is poised to produce an mega trend reversal (regular readers of this blog know what that means), which has further upside potential for something beyond a tradable rally.












And from a comparative performance perspective, the non confirmation in early March has been rewarded with a far superior run thus far.












Investment Strategy Implications

The above provides a very brief description as to why emerging markets have exhibited and will likely continue to exhibit outperformance vis-à-vis developed markets. But don't take just me word for it - Mohammed El-Erian (Mister Bumpy Road to the New Normal himself) seems to think so. And he controls a lot more money (and influence) than little old me.

In A Pig’s Eye

Money has no soul.

There are times when investing is a very callous business. Such times are now when investors must dispassionately assess the investment consequences of the swine flu disease. In this regard, it is advisable to recognize that the economic (and thus investment) impact of the virus as being more systemic than specific*. While selected areas of the global economy will likely be impacted more than others – such as travel, the more significant impact to the markets rests in a rising risk factor via the uncertainty element. Therefore, whenever risk goes up, certain valuation model inputs also rise thereby pushing valuation levels lower. Hence, price declines.

Investment Strategy Implications

Right now, fears of the economic impact from a pandemic are more systemic than specific. In a fragile economic climate with most valuation readings at fair value and technical analysis readings neutral at best, it didn’t take much to tip the stock market balance to the downside. The equation is rather simple – risk (in the form of uncertainty) went up, prices go down.

In a larger context and on the assumption that a pandemic does not emerge, there is every reason to conclude that stocks are close to the end of their short-term run anyway. The tired, old adage “sell in May and go away” will likely be the case this year leaving only the boldly bullish to find the fundamental valuation and technical analysis justification for what has all the hallmarks of a bear market rally and proclaim the return of the bull. Therefore, the coldhearted investment effects of the pandemic fears are more one of timing the ensuing market pause (dip now, rally a bit, make a non confirmation high, then generally flatish for the summer) rather than precipitating a new down wave in stocks.

Now, For Another Soapbox Moment

Once again, like clockwork, the media seems to have concluded that the recent stock market decline is attributable almost exclusively to fears of a pandemic. For those less informed investors, this is what I call the “media mantra” – new news always explains why stocks go up or down on any given day. The accepted media logic to this is thus – professional investors (who dominate the trading activity) with their large research budgets and extensive experience are so naïve that they twist and turn with the news cycle. It’s as though a portfolio manager wakes up each morning prepared to make important investment decisions on the assets he/she manages based on the surprise (news) factor of the day. In my three decades on Wall Street, I know of no asset manager who acts in this manner, yet the media mantra beholden to the news cycle (and, more importantly, advertising revenues) sells this bizarro logic to the general public.

Obviously, there are times when news does move markets – but not without the fundamental and technical analysis underpinnings in place. Therefore, the news becomes the catalyst for the investment circumstances already in place. Otherwise, how does one explain that the media regularly reports that stocks rise and fall for the same reason? (ex. “Stocks rose today because of good news.” “Stocks declined today because investors ignored the (same) good news.”)

*This point is also made by tomorrow's Beyond the Sound Bite guest, David Kotok.

In Defense of Financial Innovation

There is considerable talk (much of it rather regressive) about the future of the financial system. In one camp are the advocates of a return to basic banking. Think George Bailey and “It’s a Wonderful Life”. Paul Krugman, John Bogle, and Meredith Whitney appear to belong to this group. Then there are those who believe that the system should evolve from where it was, only with better oversight and far greater transparency. By all accounts, Secretary Geithner and Mohammed El-Erian belong to this group.

As unpopular as it currently may be, I’m on the side of the Treasury Secretary and PIMCO CEO for the following reasons:

I believe financial innovation must be allowed to grow and even flourish as the benefits of risk management and opportunistic investing through derivatives, structured finance, and other heretofore unknown instruments is vital to the complex world of globalization and global capital flows. Financial innovation allows for the more efficient use of capital in new and innovative ways thereby enabling greater growth potential across most markets and economies. Perhaps most importantly, as providers of global capital, financial innovation is important to the dominant players in the markets - major institutional investors (pension funds, sovereign wealth funds, endowments, hedge funds, etc) - and their ability to manage large sums of money in the vast and growing global markets and economy. They want it. Even need it.

The George Bailey model is simplification for its own sake. A Luddite-like natural recoil action to the pain and suffering caused by the failure of proper oversight and transparency. Moreover, the Bailey model would relegate the US financial institutions to a dumbed-down version of finance completely at odds with a globalized world and economic system (not to mention the unintended consequences of assets flowing to other, more forward-thinking markets). I believe Secretary Geithner sees and understands this and that is why, much to the consternation of many old school thinkers, he is intent on keeping the current financial infrastructure in place, just fix that which went out of control courtesy limited oversight and inadequate transparency.

With better oversight and greater transparency, the benefits of financial innovation to the global economic system far outweigh the damage wrought by the inept supervision of a complex world of finance and capital flows.

Think of it this way, did FDR blow up the stock market after the 1929 to 32 crash? What he did was create the SEC, which served the system well until the free market ideologues got control of it over the past several decades and, with the aid of financial innovation, allowed the animal spirits to run roughshod over common sense and prudent asset management. Another example would be the Internet and the tech bubble blow up. Did technology innovation stop because of Enron and WorldCom and the multitudes of dotcom implosions? Of course not.

Financial innovation is a tool. And like any tool, it can be used for good or ill. You don't ban knives because someone gets stabbed. You don't ban guns because someone gets shot. And you don't ban cars because someone gets run over. Innovation is essential for forward progress. And, in the case of finance, an enabler of better asset and risk management.

Financial innovation is the baby. Don't throw him out with the bath water of poor oversight and limited transparency.

“Buy America” = Protectionism

If you are looking for one subject that will tilt an already precarious world economy toward a very bleak future, it is the "Buy America" provision of the stimulus bill currently under negotiation. For nothing in the stimulus bill – not the ill-advised earmark pork of the power starved liberal Democrats, not certain suspect components of the business tax cuts favored by Republicans, not the not-shovel-ready infrastructure spending – is more threatening to the global economy than the “Buy America” provision.

But don’t just take my word for it. Consider the warning from the EU today. Or British Prime Minister Brown when he “warned gravely against "deglobalisation" and denounced trade and financial protectionism.”

* What signal does “Buy America” send?
* How are other countries faced with economically-derived internal strife likely to respond?
* What are other countries that provide capital to the US likely to do?

While not exactly Smoot-Hawley, it is a big step toward closing the door on the prosperity that trade and globalization facilitates. Moreover, it generates more issues and problems precisely at a time when cooperation and communication matter most. And, in the process, how Mr. Obama handles this issue will speak volumes as to his governing style.

Investment Strategy Implications

At my first five Market Forecast events conducted thus far this year and on these pages*, I have raised the larger economic question, “What will be the economic philosophy that follows the death of laissez-faire, American-style cowboy capitalism?” Heaven help us if the answer includes protectionistic measures like “Buy America.”

*see Jan. 13 & 17 postings

Geithner’s Opening Blunder – China Bashing

As refreshing as the activist tone and tempo of the early days of the Obama administration may be, there is a developing uncertainty as to exactly what is the philosophy of the new administration? Take, for example, the nexus of foreign and economic policy and the comments made by recently confirmed Treasury Secretary Geithner.

What is Mr. Geithner trying to convey when he states that China is “manipulating” its currency? What is the strategy and gamesmanship behind rhetoric that can easily be construed as having a protectionist sound to it?

At a time when the threat of a global beggar-thy-neighbor mindset could develop between and among nations pressured by their citizens (leading to protectionist actions, such as the one the toy industry in India just instituted), it seems quite imprudent for a high US government official in a brand new administration whose philosophy is not quite fully disseminated to be making accusatory statements about one of the world’s most important countries.

The activist tone and tempo of the Obama administration is clearly designed to quickly seek the high ground in the battle to change the game of the political status quo. And who can blame the President. The economic stimulus package is a perfect example of the competing forces at work, with the result almost certainly being the equivalent of an economic camel – a horse designed by a committee. Therefore, getting a jump out of the starting gate does seem to be a rational tactic. However, as shown in business, the first mover advantage may not be sustainable, particularly when so many forces are aligned against change AND the advocates for change may not be completely prepared for all contingencies, including the inevitable unintended consequences.

Investment Strategy Implications

There’s a great moment in the acclaimed HBO series “John Adams” when Ben Franklin advises the volatile Mr. Adams against publicly attacking someone who disagrees with him. “He might think you are serious”, cautions Mr. Franklin. Perhaps the Treasury Secretary should heed such advice. Or, maybe the implied no-drama Obama administration is just a campaign slogan.