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Market Summary May 16, 2001
Posted Daily Between 5 and 6:30 PM EST
by Lance Lewis
from prudentbear.com
Delayed Drunken Reaction
Asia was mixed last night as Japan fell 3 percent and back below
14,000 and Hong Kong rose a percent. Europe was down early
on along with the US futures but turned higher with the US
market. We opened lower and flopped around a little on the lows.
When we didn’t collapse, in came the buyers, and we were off to
see the wizard. The rest of the day was one long rally with barely
even a pullback. Volume picked up (1.4 bil on the NYSE and 2 bil
on the NASDAQ.) Breadth was 2 to 1 positive on the NYSE and
slightly positive on the NASDAQ. Big winners were in the golds
as the HUI rose 11 percent (I bet that would surprise most
people.) Big losers were hard to find, but the airlines were weaker
as the XAL fell a percent.
AMAT reported last night, missed, guided lower, and said new
orders had fallen 44 percent sequentially. They also added that
business continued to deteriorate during the quarter. However,
they did say that they were hopeful that bookings would turn in
the next couple quarters and thought the book-to-bill ratio in Q3
would be 1. When asked about Q4’s bookings the response
was: “look, we’re not even sure about next quarter.” On the back
of all that, AMAT and the rest of the semi equips opened weaker.
When they didn’t collapse, the buyers stepped in and chased
them, as AMAT ended up 8 percent. BRCD, who sells switches to
guys like EMC, reported last night and like EMC tried to put a
good spin on things as their CEO said, “We are now seeing signs
that IT budgets may be thawing.” Obviously, they are hearing this
from EMC who said this just a few weeks ago. But that didn’t
really matter today. Today was just an across-the-board
buyathon. BRCD opened lower and then rallied 11 percent. The
rest of tech roughly followed the same pattern of opening weaker
and then launching. There was no real rhyme or reason to the
buying. I think you had a bunch of people get short in front of the
Fed and when we didn’t go down as we have seen lately after
scheduled rate cuts, they panicked. It’s pretty simple. It just
snowballed from there with Friday’s expiration adding some
juice. Financials were up as well as the XBD and BKX rose 2
percent. GE rose 4 percent. Retailers were up a little as the RLX
rose a percent. The cyclicals were the real winners today. CAT
rose 5 percent, AA 6 percent, IP 6 percent, etc… I think you get the
picture. The market appears to have made the bet today that the
Fed will be successful in reramping the economy up with the
current printathon that is underway. The next big question is do
gold, the dollar, and the bond market go along with this. It
doesn’t appear they are going to be agreeable, which means the
Fed’s attempt at reflation will fail miserably.
Oil fell 12 cents. The XOI and OSX both rose a percent. Gold rose
$3.90 to $272.40 on the June contract. Lease rates slipped
slightly. The HUI launched 11 percent to a new high for the move
as the shares continue to discount a further rally in the yellow
metal. The US dollar index slipped a touch, and the euro rallied
back above 88 cents. Treasuries were up a hair in the long end
but slipped to their lows of the day after trying to rally initially on
this morning’s weaker than expected CPI data. The April CPI this
morning rose .3 percent (.4 was “expected”), up from March’s .1
increase. As higher gasoline and electricity prices (CA just
passed a huge increase in electricity costs last night) make it into
this number over the summer, it will get much worse. In any
event, the market looks forward and not backward. So, today’s
data is pretty meaningless for determining whether inflation is
accelerating or waning. It is useful in determining the trend
however, which is currently trending towards higher prices.
Today looked like one massive short squeeze to me, but that
doesn’t mean it has to end right away. I guess too many people,
like myself, were looking for a post-FOMC selloff, and thus we
didn’t get one. Now all of those guys have to be squeezed out.
Maybe we did that today, but I suspect we’ll do a little more
tomorrow morning at the very least. Tonight, we’ll hear from
HWP and CMOS. If the current drunken mood carries over
through tomorrow, their bad news obviously won’t matter a bit as
everybody continues to bet on the Fed pulling off a reflation
miracle. If the dollar magically holds together, I suppose they
can. After all, if you can massively inflate (slashing interest rates
and exploding the money supply) with no consequences, why
not do it? In fact, why not do it all the time? We can print
ourselves to permanent prosperity. Obviously, I don’t think that’s
going to happen. This move in the cyclicals, oils, golds, and the
current ongoing break in the bond market all point to an eventual
break in the dollar, which will put an swift end to the perpetual
motion machine that people currently believe we have for a stock
market and economy. Those are just the cold hard facts. With
Friday being an expiration, anything can and will happen over the
next few days. So, we’ll see…
Be sure and check out fellow prudent bear Marshall Auerback’s
great piece on why you should break with tradition and fight the
Fed:
International Perspective - by Marshall Auerback
Printer Friendly Version
AN INSTITUTIONALISED MANIA:
WHY YOU OUGHT TO FIGHT THE FED
May 15, 2001
Now that the rate cutting season is well and truly upon us, predictably
Wall Street’s visionaries have begun to utter the classic truism in support
of equities despite continued problematic valuations: "Don’t fight the
Fed." This slogan is predicated on the notion that the US monetary
authorities have begun to cut rates and reflate aggressively over the past
few months and that such aggressive action will ultimately engender the
"V"-shaped recovery required to sustain current stock market
valuations. In this context, argue the bulls, liquidity overwhelms
fundamentals. Even long-term, dispassionate bears such as market
technician James Stack have made the point that since most monetary
measures are currently running at "the highest level since the
hyper-inflation of the 1970s," investors ought to "stay in step with the
technical/monetary evidence and ignore fundamentals because they’re
going to get a lot worse!" In our analysis of the current mania, however,
we have persistently argued that we have not been experiencing a typical
business cycle, but an asset bubble long pumped up by ever growing
quantities of credit and therefore increasingly less responsive to repeated
interest rate cuts. Simply paying heed to hyper monetary inflation in our
view is akin to treating a patient with drugs that were the cause of the
initial illness. We are now in the midst of a capital goods recession;
capital expenditure, particularly in high tech, is in sharp decline. It is
falling from an unprecedented lofty peak. It is being slowed down by the
sheer burden of debt and the consequent inability to service that debt as
saturation dynamics take hold. We have not seen anything approximating
this condition in the US economy since the 1930s. The most comparable
post-war situation is the bubble economy of Japan in the 1980s, during
which a capital expenditure boom (also fuelled primarily by debt) reached
an unprecedented 25 per cent of GDP at its peak (whereas during most of
the post-war period, capital expenditure as a percentage of GDP in Japan
was about half this level).
The Japanese analogy is also instructive in many other ways. In the
aftermath of such excesses, the unwinding generally persists for a long
time and proves surprisingly impervious to repeated interest rate cuts.
Japan has had years of virtually zero interest rates, yet nobody hears
Japanese investors arguing today that it is fruitless to fight the Bank of
Japan in spite of the central bank’s repeated cuts in the discount rate.
Indeed, for the past few weeks, we have witnessed the unprecedented
spectacle of the Bank of Japan trying to inject hundred of millions of yen
into the banking system, and having the nation’s banks refuse to accept
these virtually free funds.
We also concede, however, that there is something unique about the
current US mania, which is unlike that of the American boom of the
roaring twenties or even Japan in the 1980s. It is the sheer
institutionalisation of this mania, which in turn casts doubt on the whole
premise as to whether one genuinely should not "fight the Fed", given
that America’s monetary authorities seem every bit as complicit in
creating and sustaining the current state of affairs as any Wall Street
investment bank might be predisposed to do. The endorsement of the
current mania, and the concomitant attempt to discredit those who
question it, is to be expected from Wall Street and the money
management industry. They are in the business of earning fees, which are
directly proportional to the value of the stocks they sell, the portfolios
they manage and the corporate transactions they undertake. In contrast,
the notion of investors not fighting the Fed is ultimately predicated on an
idea of a responsible and neutral monetary authority which, however
many mistakes it may or may not make, does try to conduct policy in an
honest manner generally perceived to be in society’s best interests,
rather than a narrow coterie of speculators and investment banks.
Therefore when such supposedly disinterested authorities do begin to
conduct themselves in a way that appears to underwrite the most
egregious forms of speculation and target their monetary policy
accordingly, it is time to ask whether the old truism about not fighting the
Fed still applies.
During most speculative manias, only a minority of high-risk rollers
participate. There tends to be a mainstream scepticism of the gambling
and the revelry associated with the stock market "party". Usually
risk-averse households remain sceptical and stay away. Society’s staid
elders tend to frown. We saw this in 1928-1929 when the Federal Reserve
under Governor Benjamin Strong repeatedly warned about the dangers of
stock market speculation.
By contrast, in this bull market, despite valuations that vastly exceed
those of the peak in 1929, or those of Japan in 1989, all of society has
been onboard: a cheerleading media on CNBC, captains of finance and
industry (whose own behaviour increasingly reflects a trend of stock
prices driving corporate activity, rather than being a mere reflection of it),
the Secretary of the Treasury, the Chief Executive, and even the
Chairman of the Federal Reserve whose accounts of the technological
wonders and subsequent efficiencies of the "new era" have significantly
outnumbered his occasional misgivings about valuation. This widespread
social benediction of the bull market in stocks has led an unprecedented
number of otherwise risk averse households to commit an unprecedented
proportion of their assets to the stock market, and let the market do their
saving for them. Recognising their limitations as investors, these trusting
souls have turned to professional mutual fund managers to do their equity
market investing for them. The institutionalised character of this mania
has made possible a deeper public involvement than ever before which
has given this bull market a power that has been unprecedented in stock
market history.
It has also affected policy making of America’s monetary officials to an
unprecedented degree, as a recent Washington Post article by columnist
John Berry indicated:
"While Greenspan and other Fed officials maintain they are not in the
business of targeting stock prices, they readily acknowledge that the
market can have a significant impact on the economy and that does
concern them. For example, the weakness in the stock market over the
past year is a factor in business investment decisions because the market
can be a source of inexpensive funding for new plants and equipment.
But if investors were still driving stock prices downward -- as appeared to
be the case until the first part of April -- a surprise rate cut might have
had little impact on the market. Like an intervention in foreign exchange
markets to affect the value of a currency, officials felt it would be better
to wait until the market appeared to have hit bottom and was on its way
up.
As the market began to improve during the week before the rate cut,
another factor came into play -- Easter. The market was to be closed on
Friday, April 13, and was to close early the day before, and under such
circumstances trading volume is usually low. So if one goal, likely a
subsidiary one, was to give the market a boost, the following week was
probably a better bet."
Berry first offers up the usual official nostrum that Greenspan and other
Fed officials are not in the business of targeting stock prices, yet then
goes into great detail describing these officials’ deliberations as to when
rates ought to be cut at a time in which the condition of the stock market
appears to play the primary role in their considerations. The final
paragraph cited above makes clear that, contrary to the initial assertions,
the Fed now does appear to be playing a role in which it actively targets
stock prices. Why worry about the Easter break and the corresponding
low trading volumes around that period, for example, if the objective was
not to give the stock market an unexpected boost? And why be so public
about these deliberations (Berry and Louis Uchitelle of the New York
Times have long been viewed as unofficial spokesmen for the Federal
Reserve) if not to send a clear, reassuring signal to investors that the Fed
is in fact there to underwrite the investing public’s losses?
Deliberating upon this new reality, Henry Kissinger, in an editorial in the
Financial Times three years ago, recognised early on that monetary
policy would now become asymmetric with regard to the stock market: it
would move aggressively to avert stock market declines but would not
move in a similar fashion to discourage stock market increases.
Greenspan himself has made this more explicit in recent times (on the
bogus notion that stock market falls tend to be more rapid and violent
than rises in equities, thereby justifying a seemingly asymmetric response
to the market), and Berry’s Washington Post article suggests that we are
one stage closer to the Fed playing the ultimate moral hazard card,
whereby stock prices are explicitly supported by the monetary
authorities. But as we have noted on numerous occasions, when the stock
market is seen as too big to fail and policy is seen to be asymmetric,
thereby fostering a possible upward ratcheting in valuations, a new and
perhaps more dangerous moral hazard arises. Many investors now
perceive that the Fed has fallen into such a policy trap and have
consequently gone cynically long the stock market regardless of
valuations. In fact, they have gone long the stock market regardless of
economic and profit declines.
Global strategist Frank Veneroso notes a most interesting precedent for
this type of moral hazard. The most extraordinary market bubble of all
human history was the stock market bubble in the Persian Gulf in the late
1970’s and early 1980’s which he observed first-hand as an advisor for
the World Bank. This bubble started with speculation on the Kuwait stock
exchange and ended with an unbelievable speculative mania on an over
the counter market in Kuwait City called the Souk al Manakh that traded
largely fraudulent companies domiciled in the United Arab Emirates.
Because the wealthy citizens of Kuwait that invested on the Kuwaiti stock
exchange were "brethren" of the Sheik of Kuwait, the government
intervened to stop a severe crash in a very overvalued market in 1977
and again in 1980. According to Veneroso, this gave rise to a widespread
belief that the Kuwait stock market was too important to fail and a
corresponding belief that it was pointless fighting the trend. The
unprecedented speculation and inevitable disaster that followed would not
have occurred had there been no moral hazard created by government
intervention to bail out Kuwait stock market speculators.
The lesson of the Souk al Manakh is clear. If the Fed continues to foster
beliefs that the stock market is too big to fail, there is a risk of unbridled
speculation that will encourage households to bid stocks ever higher and
force herding relative performance money managers to stay on board
regardless of fundamental developments. This perceived "safe haven"
bid in the market in part explains why the fall in the stock market has
been coincident with the slowdown in economic activity, rather than a
leading indicator (as is usually the case). In Japan, the market plunged by
50 per cent in 1990, but the economy did not enter recession until early
1991; the stock market proved to be an accurate leading indicator for the
real economy. The real economy of the United States, by contrast, has not
been buttressed by the Greenspan put in the manner in which stock prices
have been, which in part explains the market’s delayed reaction to a
deteriorating macroeconomic backdrop last year. However, the corollary
also applies: as an apparently coincident, as opposed to lead, indicator, it
is also difficult to determine the extent to which the market truly has
discounted the "valley" of bad profits witnessed over the past few
quarters.
The authorities would probably like to see the stock market stabilize on a
permanently high plateau, but speculations fuelled by moral hazard are
dynamic systems that tend to go parabolic and then crash. Stresses are
already showing up in the credit markets: despite 250 basis points of ease
since the beginning of the year, bond yields have risen some 50 basis
points from levels prevailing at the beginning of this year. Even the
statistical sleight-of-hand that constitutes the current measure of
consumer price inflation is at a nine-year high and the GDP implicit price
deflator is at a five-year peak. The credit markets clearly recognise the
nature of Greenspan’s reckless game even if equity investors do not as
yet. There is also growing evidence that the declines sustained thus far in
the tech-laden NASDAQ and overall sideways action of the Dow Jones is
in fact causing the more risk averse household investors who invest
primarily through mutual funds to revise downward their expectations for
future returns to stocks and raise their preference for liquid assets. The
past few months have seen fund outflows for the first time in years.
In purely speculative markets past returns determine expected future
returns. What one does not know is the time lag between changes in past
performance and changes in expected future returns. Because of the deep
societal support for stock speculation and the apparent "professional"
nature of the mutual fund management of household commitments to
equities, after an almost two decade long bull market one could presume
that household expectations regarding expected future returns to stocks
would fall fairly slowly, which helps to explain the persistently positive
sentiment readings one observes, despite the massive carnage sustained
in most portfolios since the beginning of the year. This suggests that the
recent rebound in the US stock market despite profit erosion and still high
risk spreads in credit markets is attributable to a long lag between
decelerating stock prices and eventual downward revisions to expected
future returns. But the Fed apparently believes that it cannot afford to
allow such expectations to ratchet downward as this might trigger the
crash dynamics that would destroy consumption, and eliminate the last
underpinnings for the economy as a whole. Which at least provides some
rationale for the Fed’s persistent, albeit misguided, targeting of stock
prices. They seem to operate as if shifting stock prices higher will help to
buttress consumption, investment and corporate profitability, by elevating
expectations, rather than adopting policies to alleviate current imbalances
in the real economy, the correction of which would ultimately allow for a
more sustainable rise in stock prices. But even though the Fed has gone
through Alice's looking glass, leaving the familiar world behind, it does
not follow that we have to go along blindly, seduced by the notion of not
fighting this supposedly omniscient, "market-neutral" institution. To
simply follow Alan Greenspan along unquestioningly might ultimately
leave investors in a position comparable to the rats and children who
merrily followed Browning’s Pied Piper out of the village of Hamelin and
off a cliff, never to be seen again. |
