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Surviving Lehman
New York: September 14, 2009
By John Stephenson

The bankruptcy filing a year ago of Lehman Brothers, a 158-year-old investment bank, marked the start of the biggest bear market since the Great Depression. In its wake, stock market valuations were cut in half, but a year later, vigorous policy actions and unrelenting pragmatism on the part of the U.S. Fed have turned things around—ushering in a dramatic reversal in the stock market.

It was just a year ago, on the evening of Friday September 12, 2008 when a who's who of banking was summoned to an emergency meeting at the New York Federal Reserve Building in downtown Manhattan . The issue that was put in front of the banking elite was what to do about Lehman Brothers, the fourth-largest U.S. bank, which faced a certain collapse if a suitor was not found, and quickly.

First it was suggested that Bank of America Corp. should ride to Lehman's rescue. Then, it was suggested that Barclays PLC could be an appropriate suitor. But in the end, no one stepped forward to rescue Lehman and it was allowed to fail.

With Lehman filing for bankruptcy protection the following Monday morning, the stock market unleashed its wrath on the shares of American financial companies. Shares plunged as investors panicked that other financial firms would suffer the same fate as Lehman.

The insanity that gripped the financial markets has given way to the giddy behavior of late, as stocks continue to move higher as corporate earnings have grown. More than two-thirds of the S&P500 companies have beat analyst earnings expectations for the second quarter in a row, which has helped to fuel the rally. In spite of the strong quarterly numbers, the quality of the corporate earnings has been called into doubt with some analysts suggesting that growth in earnings was only possible because of massive cost cutting by companies—a feat unlikely to be repeated. But no matter how you slice it, the stock market rally has been impressive.

To some, the rally in the stock market is nothing more than a stimulus-induced high; as likely to quickly dissipate as your morning jolt of coffee. Skeptics argue that the loss of seven million jobs in the United States and a $14-trillion plunge in household net income are just some of the headwinds confronting a robust U.S. recovery. Not to mention the fact that real wage growth has been zero for most of the American workforce over the last seven years.

On the job front, the news remains bleak. Last week, the U.S. Labor Department reported that new job openings fell to just 2.4 million in July—the lowest level recorded since 2000. With the labor markets still weak, the outlook for continued consumption can't be all that good.

But in spite of all the skepticism, a rally is underway driven by rising expectations for better days to come. To be sure, some of the good news is because of one-time stimulus programs, such as the cash-for-clunkers program, where car owners were rewarded for junking an old car to buy a new one.

The Lehman collapse and what policy makers did to stabilize the economy and the market will be studied for years. To be sure, the decision to let Lehman fail was a flawed one. Policy makers had no idea how central Lehman Brothers was to the American financial system, but once they realized their mistake, the government acted swiftly to prevent other crucial firms from failing. The monetary stimulus and the creativity that Federal Reserve Chairman Ben Bernanke showed in the intervening months prevented the complete unwinding of the global financial system.

On other fronts, policy makers have learned something as well. They've learned that quick decisive action is necessary to prevent the financial system from imploding. In the second quarter, Americans received the benefits of a tax cut. Unfortunately, most of the tax cut was saved rather than spent. On the other hand, targeted stimulus programs such as the cash-for-clunkers program proved effective in boosting car sales since it directly rewarded consumers for junking an old car and buying a new one.

For my money, the recovery in the economy is real. It may go in fits and starts, but it is definitely underway. Investors should avoid sectors of the economy which are overly reliant on consumer spending and short-term government stimulus programs. Infrastructure projects and spending is one area of the economy that is likely to benefit from ongoing government programs to fix-up shoddy infrastructure and build overall competitiveness.

The way to play infrastructure investing is to buy shares in the companies that design and engineer the projects. These companies will be the direct beneficiaries of government spending and the surest way of profiting from the next wave of government intervention.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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