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Generational Dynamics Web Log for 5-Oct-2010
5-Oct-10 News -- Goldman Sachs's Cohen gives price/earnings fantasy

Web Log - October, 2010

5-Oct-10 News -- Goldman Sachs's Cohen gives price/earnings fantasy

US drone strike kills German militants in Pakistan, amid travel warnings

Goldman Sachs's Cohen gives price/earnings fantasy

Here we go again.

75% of what you hear on CNBC or Bloomberg TV is nonsense, but every now and then, something is so bad that I have to comment on it.

Several weeks ago I posted, "24-Aug-10 News -- Ariel's Bobrinskoy gives price/earnings fantasy," where I quoted Charles Bobrinskoy, Vice Chairman, Director of Research, Ariel Investments, as lying about price/earnings ratios (also called valuations).

Bobrinskoy said that the current S&P 500 price/earnings ratio is 12.5, which is "ridiculously low." This is a lie. In that article, I included the chart from the WSJ Online web site that showed that the current S&P 500 P/E ratio is 16.53, which is much higher than the historic average of about 14. Bobrinskoy misstated the facts in order to continue to convince investors to buy stocks so that he can make fat commissions.

Now we have someone who's even worse than Bobrinskoy.

On CNBC on Monday morning, I watched an interview of Abby Joseph Cohen, head of Global Markets Institute Management at Goldman Sachs. She was described as the most powerful woman on Wall Street.

Here's my transcription of part of the interview:

QUESTION: You say that a double-dip recession is not going to happen right now, right?

Abby Joseph Cohen, Goldman Sachs <font face=Arial size=-2>(Source: CNBC)</font>

Abby Joseph Cohen, Goldman Sachs (Source: CNBC)

COHEN: It looks to us as if the economy is growing more slowly than it was at the beginnning of the year, but we just don't see the preconditions for a double dip. So our judgment is real GDP growth of about 1.5% for the next several months, but then re-acceleration. ...

QUESTION: We had a very strong September for the stock market, but you think equity valuations are still very attractive now?

COHEN: We do. Goldman Sachs for a long time has had one of the lowest economic forecasts, well below consensus. Even so, we think that the scenario that's priced into the stock market is not quite is likely to unfold.

If you agree, for example, that a recession will be avoided, we think that the S&P 500 is underpriced, not just based on 2010, but also the 2011 outlook. We tend to use very sophisticated mathematical models for valuation, but if you look at some of the very simplistic models as well, things like price/earnings ratios, they are dramatically below average -- currently 13 times earnings on 2010 versus a historical average of 17 or 18 times. ...

This is really laughable because she's worse than Bobrinskoy.

First she boasts that Goldman Sachs uses "very sophisticated mathematical models for valuation." This is a very telling piece of braggadocio, and I'll come back to it later.

Then she takes the "simplistic" calculation of P/E ratio = 13, versus a historical average of 17-18.

Well no, that's a double lie. The P/E ratio is 16.53, same as for Brobrinskoy, and the historical average is just 14. (Actually, according to the WSJ today, the P/E ratio has now gone up to 17.56.)

As in the case of Bobrinskoy, perhaps she's using the P/E ratio based on "operating earnings," a purposely misleading value that ignores so-called "one time expenses," which often include most expenses. If she is, then perhaps the P/E ratio = 12-13 is correct, but the historic average for operating earnings is much lower, probably around 7-8. Please see the article about Bobrinskoy for a lot more details about this.

So what's going on here? Cohen is telling a lie. Is she a crook, or is she incompetent? We report, you decide.

Cohen undoubtedly makes millions of dollars in salaries, bonuses, fees and commissions each year, but if she ever said, "The P/E ratio is 16.5 and the historical average is 14," then she'd probably be fired. Lying is the norm on CNBC and Bloomberg TV these days, and among financial executives.

Generation-X and Boomers in financial institutions

There's another explanation for Cohen's behavior that I'd like to explore here.

Let's go back to the original causes of the financial crisis. I've been writing about this stuff for years while it was going on, and today, in hindsight, what happened is almost universally agreed to be true.

You'll recall that there was a real estate bubble, and investment banks created a market for collections of mortgage loans called RMBS -- residential mortgage backed securities.

But investment bankers weren't satisfied with already huge profits from selling RMBSs, so they found a way to slice and dice RMBSs to create Collaterized Debt Obligations (CDOs). These could be sliced and diced further into "CDOs-squared." All of these securities are now called by the catchy name, "toxic assets."

(See "A primer on financial engineering and structured finance" for how these securities were created, and see "Financial Crisis Inquiry hearings provide 'smoking gun' evidence of widespread criminal fraud" for how they were used to massively defraud investors.)

Today there's no question how massive this fraud was. It wasn't done by one or two "bad apples." Practically every financial firm in the world participated in the fraud, and Goldman Sachs was one of the leaders in perpetrating the fraud.

Within these organizations, the management structure allowed the fraud because of the unique relationship between people in the Boomer generation and Generation-X.

The financial engineers in Generation-X created the complex models and the complex securities that turned into toxic assets, and sold the toxic assets to investors. The Generation-Xers received the blessings of their incompetent Boomer bosses, who also stood to gain from fat fees and commissions. Everyone made money, except for the defrauded investors, who were totally screwed.

Now let's return to Abby Joseph Cohen of Goldman Sachs. I can't prove this, but what I suggest to you, Dear Reader, is that we're seeing a repeat of the scenario that led to the creation of toxic assets. Cohen says that "we use very sophisticated mathematical models for valuation."

Well, does she understand those very sophisticated mathematical models? Obviously not. She's too incompetent even to compute the "simplistic" price/earnings ratio correctly.

No, those sophisticated mathematical models are undoubtedly being created by the Generation-X financial engineers who report to her. And these financial engineers aren't just similar to the ones who created the toxic assets; these are undoubtedly EXACTLY THE SAME PEOPLE.

So my suggestion is that, right before our eyes, we're seeing a repeat of the same kind of scenario that defrauded millions of investors --- and the same people are doing it again.

Why are investors risk-averse?

I'd like to quote an additional excerpt from Cohen's interview because it's so funny:

QUESTION: How much growth in the S&P 500 by the end of year?

COHEN: In the S&P 500, we think fair value by year end is something on the order of 1200. And of course this is a market because investors are so risk-averse - lose a little confidence - they're not willing to look out as much into the future as they normally would.

So we think that when investors finally get to the point that they're willing to price in the outlook for 2011, prices will move higher still for the S&P 500.

By the way, this low confidence level and risk aversion is seen not just in the US equity market, but in the developed markets around the world, including Europe.

Cohen is complaining that investors are too risk-averse, which makes them unwilling to buy stocks. She can't figure out why investors aren't listening to her.

Well, for one thing, the Wall Street Journal prints the current S&P 500 price/earnings index every day, and so anyone who bothers to do even the most basic due diligence research will discover that she's lying. So why shouldn't they be risk-averse?

Additional links

The travel warning for Americans going to Europe that US officials issued over the weekend is in response to US intelligence reports that al-Qaeda is using the North Waziristan region of Pakistan's FATA (Federally Administered Tribal Areas) to train militants for attacks in Europe similar to the 2008 attack on Mumbai. This intelligence has also resulted in an escalation of missile attacks in North Waziristan from unmanned drones. A missile strike on Sunday killed eight suspected German nationals who had come to the training camps probably with the intention of returning to Germany to conduct terrorist attacks. Bloomberg

Public support for Japanese Prime Minister Naoto Kan has fallen from 64% last month to 49% now, because of Kan's kowtowing response to China's demand in the recent confrontation of the islands in the East China Sea. Reuters

(Comments: For reader comments, questions and discussion, see the 4-Oct-10 News -- Goldman Sachs's Cohen gives price/earnings fantasy thread of the Generational Dynamics forum. Comments may be posted anonymously.) (5-Oct-2010) Permanent Link
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