Professor Elam

Eddie Lampert’s Sears Holdings SHLD, a combo of the remainder of K Mart and Sears is looking for a new CEO.   After being toasted as the new Warren Buffet, SHLD jumped to about $180, today it is about $100 and market share is going nowhere. Predictably Lampert has announced a re shuffling of the organization, a new interim CEO, and a search for a new one. That of course will get the water cooler talk going around the lawmower section of Sears, eh? 

My point. Look for more re shuffling, interim CEOs, and searches for the right formula from lots of companies.  Mired in a recession, amid daily negative reports from the media, Americans are shopping less.  I doubt changing who heads what or who is the CEO fo the quarter will change that.  Still that is what most will do.

SHLD reminds me of my original Theory of Black Holes on Wall Street. I happened on this realization when I was a struggling broker working for Ross Perot during the massive recession of 1974-75. For those of you that missed it the DOW went from 1,000 to 577 by December of 1975.  Those are actual DOW values not the drop itself.  So for those of you that think DOW 13,500 is a normal state of affairs, thnk again.

Here is the Black Hole Theory. When stocks go up in price we have a positive sum game, everyone wins. While only a fraction of the outstanding shares of a company regularly trade, when the value of that fraction rises, they all rise.  As rising tide if you will, lifts all boats.  Let’s take my previous example, SHLD. From its inception it went from bout $12 to $195.  Let’s  use round numbers to make this easy. So 200-20 bucks for the stock increase is 180 x 140 M shares or about an increase of $25 Billion dollar in value. Well no wonder everyone was proud of Eddie. That is money creation that did not exist before. With their portfolio value swelled by a factor of 9x, those lucky optimists that bought the original stock had to be happy.  You will recall the multiier effect from economics. Each $1 of value created gets spent multiple times as it passes from the butcher to the baker to the candle stick maker so to speak.

Now for the Black Hole or converse side of the Theory. This would be the negative sum theory of the game.   As the stock fell $100 from 195 to 100 or so, we wiped out 140 M shares x $100 or about $14 B of value. Where did the money go?  Again only  a fraction of the shares trade every day but the value of all of them fall in total. And  in eight short months the Black Hole of Wall Street has wiped out half the value of the company.  Investors ‘lost’ half their value.  Now we are up not 9x but about 5x. Truth be told, probably only Eddie and his inside circle held shares all the way up. A  lot of folks probably piled in on the way up. They are not feeling so warm and fuzzy bout the overall 5x increase cause they may have actually lost money. And so the Black Hole takes the money away.  If a Black Hole in outer space is an absence of matter, a Black Hole in Wall Street taketh away previous gains from the later comers.

All of this relates to psychology, herd mentality, etc.  When your portfolio swells, you are optimistic, when it shrinks you pull in commitments and spending. Now imagine what has happend with a 15% overall drop in the stock exchange. That friends is a mighty deep Black Hole. And as you can see from SHLD, and many of the stocks I assigned for the presentations, their drops have been from 50% to say 80 or 90% for say  Pier One or World Market (those are retails stores). Economists may talk today of a mild recession, but as investors total their losses, the mild turns to wild.  No doubt they were talking of a mild pullback in SHLD as it started dropping from $195.  This is why economists are usually way behind the curve. They are all using historic data. As They continue to factor in for say SHLD lower and lower prices their predictions get gloomier. On the way up they factored in higher and higher prices and their predictions got ever more rosy. In inveting terms this is known as the whipsaw effect.