Hi Cary,
Not sure which article on forest fires you are referring to, but here is one on a similar theme you may find more persuasive:
Re: Jude Wanniski on the market decline Post rated (max 5)
By Gerard Monsen (rating 3.29) on 05:53 04.16.00 | Read 1170 times | Post 9667
This analysis is too simplistic. It's merely an attempt to satisfy the mind's desire to have one simple explaination for a calamity when there are truly multiple causes. After all, this is also the time of year when people make additional contributions to their IRA's and 401(k)'s. In addition, people who knew they were receiving refunds and filed early are getting their refunds already. Finally, while there was a mini-bounce last year immediately after April 15th, the hot high-tech market was in the doldrums for several months afterward.
So what really is causing the crash we're experiencing now? Market crashes are like fires. In order to start a fire, you need three things: Logs, kindling, and sparks.
Logs
Logs are the year-or-more long-term causes of a market fire. Logs can exist for a long time without there ever being a fire. People can point out the potential fire hazard, but generally, such warnings are ignored, since the wood has lain around for a long time without causing a fire in the past.
So, what are the logs fueling this fire?
1. A huge portion of the stock market was overvalued. I'm a firm believer in the New Economy and I am a deveoper in an internet software start-up company. I see the potential benefits that technology can bring our economy and our lives. But let's face it: it was getting pretty ridiculous out there. There were some companies that had no business existing at all that were getting multi-billion dollar valuations (e.g. DrKoop.com). And even many non-tech companies were getting valuations that were way out-of-kilter with their business growth rates and profit expectations.
But this reason alone does not cause a fire. People have been calling for a bursting of the market "bubble" for years, and yet the market kept right on posting record gains in almost every index. More is needed to explain the recent market crash.
2. Venture capitalists and investment bankers began pumping out one hot IPO after another. This effect accelerated in 1999 and early 2000 as we had a record number of IPO's -- both in number and in size. We had the B2C's then the B2B's then the Linux Red Hots then the Biotech Boom. The VC's convinced investors that "this company could be the next Microsoft" or "this company could be the next Cisco." The investment bankers would then issue only 5% or less of the stock float so that the stock would get a good "pop" on IPO day. Speculative brand new companies with only a small revenue stream and with bleeding profits immediately got multi-billion dollar valuations as if all of these companies had already succeeded. But while some of these companies will indeed become the next Microsoft or Cisco, the reality is that not all of them will. But with the stock supply strangled by lockup periods, the market capitalizations of these companies remained artificially high, making small start-ups look like dominating blue-chip companies.
Again, we all knew this was happening. But as long as supply remained locked up and as long as demand for the next hot IPO remained strong, it didn't matter.
3. We were in an environment where the Fed was going to raise interest rates. Now, whether you are in the Don "Greenspan is Captain Ahab incarnate" Luskin group or in the TSC's James "Greenspan's a wuss" Padinha group, it doesn't matter and I don't want to get into it here. The fact is that in the last several years, we have been in a hot hot economy, the type of economy that a typical Federal Reserve tries to slow down by raising interest rates. And the fact is that if there hadn't been a LTCM crisis, an east Asian crisis, or a Y2K crisis, rates would have risen sooner.
Again, we've known about this for a long time. Greenspan and various Federal Reserve governors have told us this many times. But it didn't matter. The market proceeded to roar ahead 23%, 25%, 30%, 80%. Many reasons were given: "Interest rates don't matter to these new dot coms," "Interest rates are already factored into the market," "It didn't matter before, why should it now?" etc.
Kindling
Kindling is the near term, six-months or less, causes of a market fire. These are the small disturbing trends that make you want to take a step back and think but don't start the fire themselves. Instead, the kindling is merely the catalyst that turns the small sparks into a roaring blaze.
1. Non-tech funds got burned last year by tech funds. Simply and absolutely burned. Fund managers who were up 20% for the year got money taken away from them so that it could go into the funds that received triple-digit returns. Individuals sold their S&P500-like funds and poured their money into tech funds. The Dow and S&P500 dropped while the NASDAQ skyrocketted.
2. But those losing fund managers weren't going to take this situation sitting down. Some of them began dabbling in these hot hot stocks as a way to protect their performance. But they were smart enough to know that they had no real idea how these stocks trade or how the companies work. At the first sign of trouble, they were ready to bolt back to the "safe" stocks they knew.
3. The best trade this spring was to short the S&P500 and to go long the NASDAQ. After this trend established itself in January, some hedge funds played this trade aggressively, ignoring the fact that such a divergence has never maintained itself for any extended period of time.
4. Individual investors, who the media had pooh-pooh'd for years, finally did start becoming reckless. Many of these investors had never seen a bear market and had learned only that stocks only ever went up and that any dip is a buying opportunity. The 80% return on the NASDAQ whipped some individuals into a frenzy and they began to use margin to purchase the hottest most speculative stocks.
5. A tremendous amount of supply came out of lockup this spring from the record number of IPO's that occured the previous year. The market for these stocks was becoming heavy. There were the obvious bombshell ones like E-Toys. But there were also the ones where secondaries seemed to work but then the stock prices would then sag through the secondary prices a few weeks later.
6. People had to get ready to pay their taxes from a record year of gains in 1999. I'll give this idea some credit. I personally didn't see a lot of selling ahead of Y2K -- instead, I saw a lot of *avoidance* of selling to prevent the need to pay such taxes. But it's reasonable to say that this could have some effect on the current market.
7. But if you're going to give tax-related selling some credit, you must also credit tax-related buying. Many people see their financial planners only once a year in the spring. These financial planners get their clients in tax-sheltered plans like IRA's, 401(k)'s, SEP's, etc. And when asked whether they'd like to be in a fund that returned 10-20% last year or one that returned 150% last year, they choose the later. "Risk. Yeah-yeah. I'm a long-term investor. Blah blah." This could have been a factor in the steep rise in tech stock prices in early March. This tax-related buying pressure could be dissipating which could also be a cause of the relative decline of the market.
Sparks
Sparks are often cited as the "cause" of fires, but the fact is that without the kindling and wood strewn around, such sparks wouldn't matter. In fact, there are sparks igniting in the market all the time -- an earnings preannouncement of a major company, bad economic numbers, a warning by an analyst at a major investment firm, etc. But in order to get a big blaze going, you need to light the fire in several places at once in a way that gets the kindling burning.
What sparked our current blaze?
1. The Clinton/Blair genonmics announcement along with Clinton's press secretary's "gaff" demonstrated how fragile the foundations were that were propping up some of the hottest stocks. The specifics of the announcement or what happened behind the scenes didn't matter. What mattered was that many hot biotech stocks lost half their value overnight based on one confusing announcement. That shook many investors' confidences.
2. March triple-witching options expiration. Hedge fund traders who had shorted the S&P500 and gone long the NASDAQ had pressed their bets too much (as Jim Cramer's wife likes to say, "Bulls and bears live on, but pigs get slaughtered"). As biotech stocks caused the NASDAQ to tumble a little, fund managers who had been itching to buy cheap Dow and S&P500 "boring" stocks took the plunge back into their favorite stocks. This caused a short squeeze as hedge fund managers had to sell their NASDAQ stocks to cover their S&P500 shorts. Puts written long before that these managers had assumed would expire worthless were suddenly becoming "in the money." Panicked, they tried to buy these puts back in an effort to salvage what gains they had made. The Dow and S&P500 had two of their largest point gains in history while the NASDAQ dropped.
3. Barrons publishes its article detailing the cash-burn rates of various newly minted tech companies. Whether the facts and tone of the article were accurate or not is immaterial. What is important was that this article heightened the general public's awareness that some of these high-flying companies could be in trouble. (My boss loved to hit me over the head with this article).
4. But investors, especially individual investors, had learned that any dips were buying opportunities. The NASDAQ bounced around and even broke above 5000 again. But there was a "The Emperor's New Clothes" feeling about the market. Abby Joseph Cohen announced her shift to a "market-neutral" 5% cash allocation. Hedge and mutual funds tried to prop up their favorite high-flying stocks for quarter-end window dressing, but the NASDAQ creeps downward anyway.
5. Margined investors started getting forcibly sold out of their positions by margin desks. This happened during each step of the decline. This is an important development, because unlike what CNBC would have you believe, individual investors tend to "buy and hold" and not get shaken out by every drop in the market. But margin clerks don't care. Aggressive individuals didn't learn by being sold out during the first triple-witching decline. That decline and the subsequent rise just reaffirmed individual investors' "buy the dip" mentality that had served them so well before. But as stocks kept going down at the end of March and as investors started getting sold out, individuals started realizing that what spare capital they had possessed had already been spent during that first triple-witching drop.
6. The DOJ-Microsoft settlement talks broke down and Judge Jackson issued a stinging judgement against Microsoft. As many of you know, I am firmly in the "break up Microsoft" camp, but even I cannot ignore the effect these developments had on the market. What was clearly a company-specific issue nonetheless spooked investors in general as they saw the company with the largest market cap in the world lose 25% of its value in two days. The psyche of the market was shattered.
7. Momentum funds which had at one time been up 50% on the year and were suddenly beginning to approach the break-even mark began selling stocks to preserve what little gains they had remaining. Margined investors got sold out even more heavily.
8. Greenspan made statements indicating that the recent drop in the market will have no effect on his decision to raise interest rates. A bad PPI number then came out confirming that the Fed is still likely to continue to raise rates. (Remember that the Fed is a big log in this analogy. These actions reaffirm that this log hasn't been taken off the fire, yet).
9. Investors have to sell stocks before their tax filing deadline so that the cash will settle before they pay Uncle Sam for last year's gains. I don't know if this is a genuinely large effect, but it could be one.
Fire Extinguishers
So what stops the fire, and most importantly, when does it get extinguished? Ashes need to be scattered and logs needs to be patted down before the flames can truly be extinguished. I feel that the following things need to happen before the fire gets contained:
1. The flood of stock supply needs to be dammed up. Deals need to get canceled and VC's need to stop selling their stock. Jim Seymour and Adam Lashinsky said on TSC's TV show that they think the AltaVista deal will get postponed. That would be a good start. If some IPO's and secondaries get canceled, that would be a good sign. (This would clear up some kindling and maybe a few logs as well).
2. Aggressive margined investors need to get truly shaken out. That means we need to stay down here for at least a couple days. Otherwise, such investors will think that it's just another "buy the dip" period and they won't have learned anything. Stock needs to flow to more reasoned investors who know what they own, why they own it and won't be stupid about being too aggressive with it. (This would clear up some kindling).
3. The chaff companies that had no business existing in the first place, much less be multi-billion dollar market cap companies, need to be separated from the "good" companies and get burned completely. DrKoop.com is an excellent example. Another metaphor is to say that the dead branches need to be pruned so that the live ones can grow and blossom. (This would remove or pat down some logs).
4. Stocks will need to be sold to the point where people start saying, "This is ridiculous." There are already some reports coming out of some dot com's being sold down to their cash positions. When more of this happens, it means that the fire is starting to die out. (This would scatter some logs).
5. Perhaps April 17th's passing will automatically end some tax-related selling pressure. (This would remove some kindling).
6. The Fed will need to reach a level where it's done raising interest rates. I think the Fed will continue to raise rates two more times before they are done. Again, I don't wish to get into a debate here about whether or not the Fed *should* be taking this action. I am merely stating what I think the Fed *will* do. Once the Fed is done raising rates, that will be a big log removed from the fire.
When? When?
I don't know. That's why I pay Don and Maurice the big bucks. *smile* I think this summer is going to be a dreary one with the NASDAQ trading in a range and rarely bobbing above the 4000 level. I don't see the NASDAQ popping above 5000 until at least October. But I can't time the market any better than anyone else which is why I put in an order for more OpenFund shares on Friday. And if the market's still cool two weeks from now, I'll drop more money in. I do think the market will sort itself out eventually, though. Call me an optimistic unmargined "buy on the dipper."
Geri
P.S. I hope this gets listed as a "Post of the Day." I worked pretty hard on it.
community.metamarkets.com |
