Week in Review

With Europe making the headlines again, it comes as no surprise that equities have been selling off considerably.  As of Thursday's close, the Dow has finished to the downside in 11 out of the last 12 trading sessions.  The "sell in May and go away" strategy appears to working, yet again, much like it did in 2011 and 2010.  The cause for concern now is that many people fear that Greece might exit the Euro zone.  As a result, this might cause a run on some of the other southern European banks, like in Spain, Portugal and Italy.  Some would even consider this as a Lehman Brothers type scenario unless some resolution is agreed upon before it gets to that point.  Regardless of stock valuations and fundamentals, investors have been motivated to take the “risk off” approach in the near term.  The markets have been in either full “risk on” or “risk off” mode for the last several months.

However, some have argued that this year should be one to stay invested.  Return data for election years in the past has actually proven to be quite rosy in most instances.  In prior election years, (2008 excluded), the markets have shown considerable strength, especially between the spring and autumn months.  See yearly results here.

S&P 500 Stock Market Returns During Election Years
Year	Return	Candidates
1928	43.6%	Hoover vs. Smith
1932	-8.2%	Roosevelt vs. Hoover
1936	33.9%	Roosevelt vs. Landon
1940	-9.8%	Roosevelt vs. Willkie
1944	19.7%	Roosevelt vs. Dewey
1948	5.5%	Truman vs. Dewey
1952	18.4%	Eisenhower vs. Stevenson
1956	6.6%	Eisenhower vs. Stevenson
1960	.50%	Kennedy vs. Nixon
1964	16.5%	Johnson vs. Goldwater
1968	11.1%	Nixon vs. Humphrey
1972	19.0%	Nixon vs. McGovern
1976	23.8%	Carter vs. Ford
1980	32.4%	Reagan vs. Carter
1984	6.3%	Reagan vs. Mondale
1988	16.8%	Bush vs. Dukakis
1992	7.6%	Clinton vs. Bush
1996	23%	Clinton vs. Dole
2000	-9.1%	Bush vs. Gore
2004	10.9%	Bush vs. Kerry
2008	-37%	Obama vs. McCain
2012	?	Obama vs. ?

Being that 2012 is an election year, there has been speculation amongst analysts that this year could surprise many in a positive way.  Unfortunately, the last three weeks have come to prove that a positive surprise might not come so easy.  Volatility has ticked up, and near term concerns seem to far outweigh any positive prospects for the longer term.  As long as issues in Europe continue, it will likely be on the mind of investors.   

At the same time, Facebook goes public today, (ticker FB).  This comes at an interesting time because it seems to be stealing a lot of the market’s thunder recently.  There seems to be less interest on the markets shifty movement and relentless emphasis on what will be the largest internet IPO in history. 

Liquidity and Markets

Many investors (and analysts for that matter) mistakenly believe that stocks are driven strictly by the underlying fundamentals, such as GDP, employment rate, interest rates, etc.  While it's true the economy can have an impact on the stock market, it's not the main reason stocks move higher or lower.  The main driver of stock prices is liquidity - either excess or lack of.

If there is excess liquidity in the system, some of that cash finds its way into stocks and other assets (real estate a few years back, remember that?).  One important by-product of a solid growing economy is a liquid market, which means stocks rise. However, the economy itself is only impacting the market indirectly. The reverse is usually true in a bad economy.  Poor economies lead to a liquidity crunch (think saving and paying down debt) and stocks usually fall. 

To understand the concept of liquidity vs. the economy as a driver of stocks, simply look at the Nasdaq Composite, which was recently trading above its 2007 high. So we ask ourselves is the economy as good or better now than it was in 2007? Obviously it's not better - so if the economy were truly the driver, then the markets would be substantially lower, since things are worse than in 2007. So why aren't the markets lower?  The answer is liquidity.

Since 2009, the massive money printing from the TARP bailout, the ECB's LTRO, QE1, QE2, Operation Twist, and so on, have provided the liquidity to keep stocks moving higher.  In addition, lower interest rates have allowed corporations and consumers to borrow funds, which in turn creates more liquidity. As far as we can see, this liquidity is one of the only factors driving stocks higher. The amount of liquidity injected into the system in recent years has been beyond comprehension - trillions and trillions of dollars. 
That liquidity usually gets confused with "real" money, and gets spent as actual money, which drives stocks and other assets higher.  "Real" money is actually money created when an economy produces more than it consumes.  In other words, real money comes from production and economic growth.  In the current world, there is limited production and growth; so the prime mover driving asset prices is the printing presses.

As long as the liquidity is there, it's supportive to global markets, especially with interest rates so low.  But what happens if the printing presses stop?  Where will the liquidity come from?  If we assume it will eventually come from production and growth, what happens when the global economy can't grow at a rate fast enough to produce the same amount of liquidity that governments are currently providing, then what?  Wish I knew the answer.

Facebook IPO

While I don't have a Facebook account, I do realize that almost 1 billion people across the globe use Facebook in some form.  With so many people connected via Facebook, I thought it made sense to discuss its upcoming venture into the public marketplace.

According to recent reports, Facebook set the price range for its initial public offering at $25 to $35 a share, in a landmark deal that would raise as much as $13.5 billion for the social network and its insiders.

The preliminary price range would value the company at $75 billion to $100 billion. It puts the social network on track to become the most valuable U.S. Web company at the time of an IPO, exceeding Google's $23 billion valuation in 2004. It would also put Facebook just behind the market capitalization of Amazon and ahead of other tech giants like Hewlett Packard.

Chief Executive Mark Zuckerberg's stake in Facebook is valued as high as about $18.7 billion. Mr. Zuckerberg will also hold or have the ability to control approximately 57.3% of the voting power of our outstanding capital stock following this offering.

The social network is now about two weeks away from a final pricing and the first trading of its shares under the symbol FB.  The planned price range of $25 to $35 is on the lower side of what some analysts and investors had expected. On the private-company exchange SharesPost, Facebook shares were last trading at roughly $40 per share.

 

Associated Press

Facebook CEO Mark Zuckerberg

Facebook's reach is unprecedented. The company, founded by Mark Zuckerberg and some Harvard University students, is now fast approaching an audience of one billion, and it continues to draw users from numerous demographics and international markets. It's now expected to enter the sensitive—but massive—Chinese market.

Still, some recent financial disclosures by the company put a damper on enthusiasm about its impending IPO. Unlike many other Web companies that recently went public, Facebook is profitable. But the company recently disclosed that its profit and sales dipped in the first quarter of this year, compared with the prior period.

Sales in the period fell 6% from the fourth quarter to $1.06 billion, while profit slumped 32% to $205 million. In 2011, Facebook posted a profit of $1 billion and $3.7 billion in sales, compared with a loss of $56,000 and $272 million in sales as recently as 2008.

While Facebook makes money, which can't be said for many other Internet companies like Groupon, for example; it faces the significant challenge of exponentially growing revenues and earnings over the next few years in order to fully live up to the hype and justify its lofty valuation.