It Wouldn’t be a Real Bear Market Rally if it Didn’t Test Your Confidence in Your Position

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It is the age of optimism. Or at least the week of optimism. Or the age of denial. Or lack of thinking.

Perhaps it’s too early to say. But after the long holiday break and the news that Goldman Sachs somehow eked out US$1.8 billion in earnings in the last quarter, you get the feeling that the Aussie market might enjoy a stroll in the green today.

The futures were pointing north this morning (up 63). So yes, it does look like the rally that began in March may keep rolling on in mid-May. Anecdotally, we’re sensing this rally has legs too judging by the number of people calling us an idiot via e-mail. It wouldn’t be a real bear market rally if it didn’t test your confidence in your position.

That said, it should be a quiet week as traders work off their hangovers from the weekend. This gives us a moment to discuss earnings. The Goldman result is one of those stories that give the impression it is safe to get back in the water. But earnings don’t always tell you what’s going on with a business, mostly because, as my friend Dan Ferris says below, earnings are “fictional.”

Dan says that in his experience, “The bond market is far more efficient than the stock market. Bond investors focus on the likelihood that a company can repay its debts. They analyse the cash-flow statement and the balance sheet. Of the three common financial statements, these two leave the least room for imagination. Cash can be counted. Assets can be priced.”

“Stock investors, on the other hand, tend to focus on something called ‘earnings,’ which are reported on the income statement. Earnings are fictional. They are a product of modern accounting, most of which seems to have been designed to sucker naïve investors. If financial statements were genres of books, you would say the cash-flow statement is an honest memoir, the balance sheet is a well-researched biography, and the income statement is fantasy science fiction.”

“Goldman Sachs, for example, claimed to have ‘earned’ more than $20 billion over the last three years, but actually lost more than $100 billion in cash. Which do you think is likely closer to reality? Or look at MGM. MGM claims to have $3 billion in ‘earnings’ over the last three years. But looking at its cash flows, it seems like it really lost about $2 billion, which is why it was forced to add yet another $1 billion to its debt load.”

“Just make a note and stick it on your computer screen,” Dan advises. “Don’t buy stocks that have wide and continuing discrepancies between what they report in earnings and what they make in cash. Don’t buy stocks that add, continually, to the amount of debt they carry. And don’t buy stocks whose bonds are trading at a huge discount from par.”

More on cash flow, the income statement, and the balance sheet tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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6 Comments on "It Wouldn’t be a Real Bear Market Rally if it Didn’t Test Your Confidence in Your Position"

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Greg Atkinson
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It is funny that no matter how many times we go though these bear markets we always tend to end up questioning the future of capitalism, free markets and the global economy. But then in a few years time I suspect we will all be doing our little bit to fuel another bubble :)

So maybe we should start talking about what the next bubble will be? Any ideas anyone? How about a renewable energy bubble?

Ross
Guest

Thanks Dan.

Pete
Guest

Love the title of this one. Its a good point Dan, and it’ll get a bit worse yet. Don’t let the bulls cloud your vision. Sucker rallies are for suckers and risk loving short-term traders.

Good points about ‘earnings’ too. So much for value investors eh?

Sammy
Guest

C’mon, enough with the doom and gloom. The markets are recovering, the good times have come back! Everyone should be investing in the market asap, because when stocks reach their yearly highs again, it will be an opportunity lost for the scared investors believing that everything is going down the toilet.

rick e
Guest

sammy lend me some money

Greg S.
Guest

Sammy,

Great looking rising wedge forming in the S&P 500. Lend me some money also.

wpDiscuz
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