March, 2008

From the Desk of Richard Esposito

It's almost April, Spring is here, but something's missing. Even with the extra "leap year" day we got on February 29th, 2008 just doesn't feel right.

Could it be because Easter was the earliest it's been in the last 152 years (with Passover over a month after Easter this year)? Christmas-New Year's break ended and presto, the family was gathered at our place to eat a roasted lamb dinner followed by a dessert of home-made Italian pizza grana and chocolate covered strawberries (hand-dipped by our youngest son – the result of the best kind of inspiration: one acted upon).

Maybe it has something to do with the collapse of Bear Stearns. March 14th began as a normal Friday and ended with one of America's premier investment banks in ruins. Stuff happens, but this was beyond anything we or anyone we know had ever experienced. It's one thing for a stock to "gap down," but Bear Sterns dropping from $57 to $2 in three days? Incredible. And disturbing. What's going on?

(If you're interested in our thoughts on the Bear Stearns debacle, you'll find them at the end of our letter: What the collapse of Bear Stearns really means)

That same night we took our first shot at Wagner's epic Tristan und Isolde (Tristan and Isolde) at the Metropolitan Opera. The tenor (Tristan) called in sick (it happens). The problem is there are only a few hearty men in the entire world who can sing this part. On top of that, the fellow who stepped in had never sung the role in public. And now he would debut his Tristan at the Met in front of a packed and restless house.

Things seemed to be going well until Act Two. Then came the passionate "love-death" duet. The two lovers, driven by a mysterious love potion, draw closer. The music swells as the lovers' hearts beat faster on a darkened stage.

They were actually singing in German, but you get the point. In the midst of this exploding passion, Isolde runs off the stage. Was this the director's strange idea of a creative twist? (It wouldn't be the first misguided attempt to improve a great moment in opera.) Tristan urgently carries on as the curtain and house lights slowly come down:

Turns out the soprano got sick – a "stomach ailment" we later read. (Glad I wasn't the stagehand who had to greet her in the wings.)

Poor Tristan. What a debut. But, troopers that they are, the Met staff continued the opera after a pause – with a new Isolde! (At least she had sung the role before.) The love-duet continued (we'll spare you the rest of the libretto), with passion quickly unfurled, on to its adulterous climax.

Given the delays and the fact that a night at Tristan und Isolde normally runs a good 5 hours, we considered leaving after Act Two, along with some of the less hearty patrons who'd reached their physical and emotional limit. Fortunately we decided to hang in there until the thunderous applause and bravos rang out after almost 6 hours of love, passion, adultery, betrayal, and reconciliation, as both lovers lay dead in each other's arms, joined forever in eternity. It is opera, after all.

In contrast to Bear Stearns' collapse that afternoon, the Met Opera refused to give up the ghost over a few sick singers. (Two Tristans and two Isoldes in one night may be a record. Though there was once an Isolde who needed three Tristans to complete the opera.) It was, to be sure, a night to remember.

Maybe feeling a bit disconcerted is only logical given the situation: record early Easter; record collapse of a major financial institution; record number of total Tristans and Isoldes – all within 9 days of March. No wonder I feel I'm not in Kansas anymore.

But with it all, Spring did debut on March 20th, right on schedule. Count on the Seasons, if nothing else. They never waver. It may be a bit chilly, but we checked the park and the robins have indeed arrived and are hopping about. Bad for the worms, but good for our spirits.

We need some things to stay the same in a world of constant dizzying change. As long as Easter gets here each year, I'm good. As long as they keep playing and singing the notes, Tristan and Isolde will keep loving and dying, and I'll probably keep buying a ticket. As for Bear Stearns, well, that's another story.

The world keeps spinning and time goes on. Things may not always happen as we might have planned. But no one ever said it would be easy.

Wishing you the warmth of Spring – whenever it finally arrives.

This past March 14th the law of Wall Street, a.k.a the law of the jungle, prevailed, as it always does. The big fish ate the little fish. JP Morgan opened its massive jaws and swallowed up Bear Stearns. The swiftness of the demise of the old esteemed investment bank took our breath away.

We've read the commentaries and analyses, each one attempting to explain why and how it happened. But each left us with more questions. We're still digesting it all, even as JPM begins digesting Bear Stearns.

Even if we had settled down and thought we understood the goings-on, the most recent twist in the story would have kept us on our toes. Instead of buying Bear Stearns for the announced price of $2, JP Morgan is now paying $10. They say it's to keep the BS stockholders happy.

But wait. Does that make sense? First the price of Bear Sterns collapses. JP Morgan steps in to "rescue" Bear. $2 was better than nothing, they said. Now they're going to pay $10. What's going on?

Let's roll back the tape. On Thursday March 13th, Bear Sterns closing price was $57. On Friday March 14th it was $30. By Sunday March 16th, it was announced that the Federal Reserve had negotiated with JP Morgan to buy Bear Sterns for $2. Where did the price of $2 per share come from? The Federal Reserve surely didn't step in because the price of Bear Sterns stock fell almost 50% in one day, from Thursday to Friday. It's not like that's never happened to a stock before. Then, all of a sudden, over the weekend and behind closed doors, that $30 becomes $2.

So right away, the question of what the Fed was really doing comes up. Were they saving a company from bankruptcy? But that's not their responsibility. It must have had something to do with a greater threat of some sort. Something that would have threatened our whole financial system. Right? Only that makes any sense.

So it must have been a threat to our entire financial system that caused the Fed to stop history and the free market dead in its tracks on March 14th. They called on JP Morgan to buy what was left of Bear Sterns. After a series of negotiations, they decided on $2 a share.

But if JPM had negotiated a fair deal at $2 per share, why are they now offering to pay five times more than the negotiated price. Repeat: they are offering to pay five times more than the price they negotiated on March 16th. Does any of this make sense?

While we're wondering, we're struck by another rather strange series of events: the action of the stock market. At first, the market cringed. But then it leapt for joy.

At this point, frankly, we're going to wait and give this a little more time. For now, we'll defer to what the stock market has told us so far.

Here's why we're checking in with the stock market to get our bearings: the stock market, as a rule, is a "discounting mechanism." It purports to tell us what's up in the future – somewhere 6 months to 18 months or so down the line.

So what's it telling us? So far, so good. Surprised? You should be. Consider that, besides the whole Bear Sterns debacle, everyone's been saying we're in a recession. In addition, investor sentiment and consumer sentiment have hit low, and I mean LOW points. Yet this stock market prefers to accentuate the positive and eliminate the negative. Let's look at some specifics.

On January 17th, the Dow Jones Transports recorded a low of 4,140.29. A few days later on January 22nd, the Dow Jones Industrials recorded a low of 11,971.19. Since then, the two Averages together have not been lower. The "together" is the important word. There was not a single day when both Averages have closed lower. And this in spite of all the bad news, volatility and negative sentiment.

Since December, we'd had, at one point, nine 90% down days. These are days measured by Lowry Research Corporation that indicate panic selling. Yet we didn't see a new low in the Industrials and Transports. Then, on Tuesday March 19th, only five days after Bear Stearns' collapse, we saw a 90% up-day – a day of panic-type buying.

This all may be more than you wanted to know, but the point is this: the stock market has not and still does not discount disaster ahead. Even with all the comments about the housing market's decline, perhaps even impending collapse. There is still no clear negative signal from the collected wisdom of the smart big money on Wall Street.

Well, we started out asking what the collapse of Bear Stearns really means. And instead of answering the question this month, we're looking at what the stock market is telling us about the next 6 - 18 months. Lesson: when in doubt, listen to the language of the market. Listen carefully.

And yet, even now, we wonder. Even if the market is discounting all the potential disasters of the next 6 - 18 months, there's still what lies beyond that. We don't, after all, invest for the next 6 months.

At this point, perhaps the best we can do is to agree with the king of Siam in Rogers and Hammerstein's musical "The King and I." This wise character looks at a world turned upside down and declares in his Siamese-accented English: "Is a puzzlement."

We'll take a pass on fighting for what we do not know is so. We'll leave that to Wall Street and the Fed. For us, there's enough challenge in watching, listening, and trying our best to learn the lessons the market may be trying to teach us. Because there's one thing we are sure of: there's a lot at stake this time. More than Wall Street, the Fed, and most of the pundits are letting on, or even know.

As for what the collapse of Bear Sterns really means, it looks like right now the market is saying we may never find out. Or it could be something we'll find out when we least expect it. We suspect we'll have more to say in upcoming letters.