Let's try to straighten out a few things. Are we in a recession, or aren't we in a recession? Could Google (GOOG), IBM (IBM), Ebay (EBAY), or Intel (INTC) do what they just did if we are in a recession? I hear commentator after commentator state that the current recession is a fact. In an interview with Tim Russert, CNBC correspondent Maria Bartiromo summed up Wall Street consensus perfectly when she said:
We could be talking ourselves into a recession..because all of the headlines and all of the negativity out there.To help clarify why sentiment got so bad so fast, it's important to understand two important dynamics.
First, we're dealing with financial sector weakness. When the financial sector feels pain they make sure everyone else does too. The Enron-induced mark-to-market disclosure laws forced our institutions to take unprecedented writedowns as real estate prices corrected. Loan defaults weren't the problem, dropping CDO valuations were. This unintended consequence turned a normal, healthy real estate correction into widespread nightmare. We have dealt with similar corrections before, but this one has been different. On April 10, Fed Chairman Ben Bernanke said:
...mark-to-market accounting has been sometimes destabilizing in that sales of assets into very illiquid markets had led to reductions in prices, which have caused writedowns which have sometimes caused firesales, and you get into an adverse dynamic which has caused problems in some of our markets.
U.S. banks and brokerage firms are not accustomed to volatility. Once the massive writedowns started pouring in, many on Wall Street saw their careers flash before their eyes. Instead of conducting unbiased research and making smart, long-term investment decisions, they worked themselves up into a frenzy with questions like, am I going to have a job tomorrow? Who are we going to merge with? Will my world ever be the same? Their traditional culture of stability had been replaced by a culture of panic. The entire investment world revolves around the decisions made in New York City, but for a few months New York City was reeling. Since they were experiencing a recession, it was assumed everyone else was as well.
This phenomenon turned the entire market into a group of day traders with no memory of yesterday and no thoughts of tomorrow. We fluctuated from data point to data point like a ship getting tossed in rough waters. None of this panic occurred when the auto industry fizzled, and it didn't happen because of bankruptcy threats among the homebuilders either. It only happened because this crisis directly affected our most influential decision makers on Wall Street.
The second reason why panic struck is a simple calendar issue. What happens during the first half of an election year? Voters elect Presidential nominees. What do these nominees talk about in every interview and in every debate? Change. It is their job to paint a negative picture of our economy so they can come in and clean it up. That's exactly what they did. Consumers were bombarded with statements of negativity even though they still had their houses and their jobs. After all, unemployment levels are still near historic highs.
The daily political rhetoric confused Americans and added to the financial crisis. Politicians began to hold hearings, activist hedge funds began spreading rumors that caused unneeded runs on banks at Etrade (ETFC) and Bear Stearns (BSC). Now that these loud voices have quieted down where does that leave us? It leaves us with a major disconnect between perception and reality.
However, we are witnessing the reality during this earnings season. So far the companies who don't have exposure to financials or housing can be bought. This week saw Intel, IBM, Ebay, and Google all report stellar earnings results with positive outlooks on the future. The credit crisis hasn't touched them as we feared it would. The fear expressed so often in the media caused many investors to sit on the sidelines in cash - they must have been sick watching the Dow rise 228 points and Google adding $90 on the same day Citigroup (C) announced another $13-billion in write-downs.
If we are in a recession, it's a new kind of recession. One that is a stock pickers dream if you can pick out the companies unaffected from the turmoil. Just because a few sectors are weak doesn't mean the entire system has to implode. It is time for those companies who have been unjustly punished to rise back up where they belong. Because of the mark-to-market rules I still wouldn't touch financials until we see a turn in real estate prices, or until that law gets changed. Other than that, last week showed us some important trends taking place. It's time to be invested in the new recession.
Disclosure: The author owns GOOG.