The Dangers Of Wall Street’s Garbage

When garbage floats to the top, then it’s time to get out of the water.

That was the warning from a manager at the Caribbean resort where my family vacationed last spring. Apparently, cruise ships dump their garbage several miles off the shore of the island and about once a week it floats to the surface and washes onto the beaches.

During those times, the bacteria level in the water is high. So it’s best to stay out of the ocean.

Funny. I didn’t remember reading anything about this in the brochures for this swanky four-star resort. But I did think about the manager’s warning last week as shares of American International Group (AIG) spiked more than 100% higher - and again yesterday as Freddie Mac (FRE) shares doubled overnight.

Wall Street’s garbage is floating to the surface and leading the way higher.

Think about it… it’s not high-quality names like Apple (AAPL), Intel (INTC), ExxonMobil (XOM), Wal-Mart (WMT), or Colgate (CL) fueling this rally since mid-July. Those stocks have vastly underperformed the market. It’s garbage like AIG, FRE, Fannie Mae (FNM), and other speculative names that rocketed higher over the past two weeks.

Chasing speculative activity on Wall Street is like swimming in an ocean filled with used toothbrushes and dirty diapers. You may think you’re safe if you don’t come in direct contact with the garbage. But the rash you get a few days later convinces you otherwise.

I’m reluctant to compare today’s market activity to what happened during the Internet bubble in 1999 - when virtually bankrupt stocks like K-Tel ran from $6 per share to $30 on the announcement it was starting a website. But the speculative activity with stocks like AIG and FRE is similar.

There is no fundamental rationalization behind this move. Neither AIG nor FRE are viable long-term investments. Their recent earnings reports are about as factual as a Harry Potter novel. But they did serve to push short sellers to cover their positions and for speculative momentum buyers to swim ahead of the tide and race the garbage toward the beach.

Today is different than 1999, however. Back then, everyone seemed to know they were buying junk… They were hoping to jettison the shares before the music finally stopped.

Today, people think they are buying real value… that somehow companies like AIG, FRE, and FNM will regain their past glories and a rosary reading accompanying one or two positive earnings reports will forgive the sins of the past.

Markets don’t work that way.

Markets ebb and flow like the tide. And when the tide is filled with garbage, it’s best to take the advice of the manager at the four-star Caribbean resort and get out of the water.

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