Great post from Prudent Bear:
If I was a bull, the biggest concern I would have is the S&P index. First there is a nice head and shoulders that was broken. Second, 1190 is the top of the 1996-1998 swing. That point, more than any other point in any index is one I see that cannot be violated. The S&P is the capitalization of the market and if the market enters into a territory where it is less valuable than it was at that point, it is sure to take all the indexes with it. It and the Nasdaq are almost in direct sympathy with each other and both are threatening that high July 98. This is important because the Dow makes up about 30% of the value of the S&P at this point and still has a nice cushion above it. I think a break of 10,000 gives us a great chance to have a crash, based on my Elliott count and the diamond top. THIRD WAVES OF THIS TYPE ARE ALWAYS CRASHES AND THIS ONE WILL BE 2000 QUICK POINTS AT LEAST.
There are a few other interesting things going on. The long bond has moved up in yield and is 10 basis points higher than on the day the fed cut rates in early january. We are also having currency crises in places like Turkey, a sign there is a lack of liquidity in the world, which always shows up in countries with weak internal economies first. The US is the money machine in the sense that we have the money machine, but we have extreme exposure. There is going to have to be an asset sale to keep the dollar up. I would sell all stocks right now as chances are great there will be a 20% or more drop in prices quickly.
The alternative is we rally off these bottoms. I don't expect that to happen, due in part to the action in the Nasdaq. I don't believe the Nasdaq was supposed to do what it has done in a 4th wave and this would mean we are either in the 5th wave or the 5th wave of the third wave, which I give little chance because of the size of the rebound in the Nasdaq in January. It looks to me like these high priced tech stocks are now in the process of seeking more reasonable values, as there isn't much likelyhood for growth and maybe even massive losses this year in that industry. Prices based upon high growth rates (20 to 30 percent a year) melt when there is no growth, as literally that one factor is worth about 20 to 30 percent of the value. In fact, PE's above 50 discount the idea that there could be a no growth year to the point that it isn't supposed to happen. I would put the adjustment in those companies to a PE of 15 to 30 upon realization that the no growth only going to happen but is happening.
We are about to find out about the money on the sideline. I don't think there is enough. One thing that was published in Investors Business Daily 2 weeks ago was the ratio of public shorts to specialist shorts. It was supposed to be bullish that the public was more short than the specialists. Maybe both of them were massively short, but if Wall Street wasn't short that massively up the, then there is a possibility they may have been long all the way down. I think Wall Street has been short on every top if one does their research and they have been able to reverse position and hold the market in the past. If they weren't substantially short at the top and been the ones selling this market down, then they may be getting to the point the cannot only not buy stocks, but are required to sell themselves. Remember, these are kids that have lived their entire lives in bull markets or at least the portion of their lives that they can remember outside of a cyclical bear market. I'm finding the early to mid thirty somethings don't believe the world can get back the way it was and stock traders are generally pretty egocentric.
Anyhow, we have the makings of a crash coming up pretty quickly. If it happens, there should be a rebound before, but not necessarily. We may have already had the rebound in January. If my speculation of the street being long on the top holds true, then their hands are tied as to how to reverse this animal. This means more fuel to the fire of what made this thing go up so much is the same thing that is going to make it go down, borrowed cash and proper market timing by the street. The $30 billion that came into mutual funds in January won't buy the stock traded on this market for a day. We are getting into an area where there could be massive call money liquidation, draining billions of cash from the market. I would also gather, $30 billion won't cover what wall street is now taking out of this market a month in fees, meaning the market mechanism itself is destroying the means of keeping the market up.
You have to remember that most of these idiots on Wall Street have defied financial reality so long they have lost touch with reality. I had a debate with an online bullish analyst and I questioned his idea that the fundementals were bullish on all 3 major indicies, when the dow was in the high 10,000's, the Nas at 2700 and the S&P close to 1400. You throw out this market and the PE's we have right now are above historical highs for any US market in history, the Price to Book is at historical highs, the debt to equity ratios at historical highs and the dividend yield a fraction of what they have ever been. Those are not strong fundementals and if you throw in the tricks companies had done to dress up their balance sheets and the writeoffs the bubbleonians seem to ignore and you have the makings of a market of companies that are underperforming their valuations.
At this time, it looks like the market may have bottomed and is rallying. One thing I see on the screen right now that bears looking at is the trin is .74 and all the indicies are still negative (the market has since closed and the dow managed a fraction of a point gain). One could make a bullish or bearish case for this factor, but I think there is some buying in some particular stocks to try to turn the tape. What disturbs me about my current opinion is the market has never crashed this early in the year and from what I remember, almost every market crash has either happened in April-May or September-October. Had I been trading, I would have bought the Nasdaq at a break of 2300 and lost the trade. I might buy it again, as I love the counter trade, but I think the better alternative is to find a spot on the chart and sell the rally, as that seems to be the way the market is headed. Looking at a chart of Cisco, I see it has just about completed wave 3 and maybe that is an indication of where the Nasdaq really is. Microsoft completed its wave 3 in December. Maybe we do have another bear market rally coming and the timing is off between the different Nasdaq component. If that is the case, selling at above 2850 will be like shooting fish in a barrel.
Anyhow, for a trader it is still probably a bullish end of the swing and a short sell would be risky. The Nasdaq bottomed today at 2186, the S&P at 1228 and the Dow at 10372. The July 1998 highs in these 3 indicies were about 2050, 1190 and it seems a close of 9239 on the dow. I am concerned with the 10,000 level on the dow and believe at this time that a break of this number means the market gets really ugly. In fact, that number will get higher as time goes on because of the slope of the triangle. Needless to say, all the indexes took out the lows of the recent trading ranges and the S&P and Nasdaq have made long term lows in this swing, trading lower than at any time since these figures were passed in early 1999. The above mentioned July 1998 highs are what I consider sacred cows of this market and are merely a couple of bad days away for the S&P and Nasdaq. If one looks at the S&P, they will see a break in a massive head and shoulders formation that is some 300 plus points tall. That forebodes a 300 point decline, which if it pauses there, forms another head and shoulders of 600 points plus in height. It is the principal of Elliott that the market will make a bottom in the range of the 4th wave of the next lower degree and that additional 600 points would put the market in the range of the 1987 to 1990 price action. The 900 range on the S&P puts it in the range of the 4th of the next lower degree, which would give hope we still have waves 3-5 of wave 5 to go. I don't give the second Elliott analysis much hope due to the fact that October 1997 and September-October 1998 appeared to both be 4th waves, 1998 being one degree higher than 1997. The 1998 action in all 3 indicies, despite being much larger declines, held within the action of the 1997 bottom.
What all this market theory tells me is the cyclical bull market is technically still intact, but likely done. I don't believe there will be any louder signal than a breach of 1190 on the S&P. Though in theory, we could have merely experienced the end of wave 1 of wave 5 and are now in wave 2, a retracement that could technically go down to a point in the mid 900's(S&P), that is not financially probable. The 1998 lows in the 3 indicies were off the top of my head, 924 on the S&P, 1300 on the Nasdaq and 7400 on the Dow. Only the Dow, do I give any hope of us seeing a new high in this bull market as it isn't at this time in danger of violating any real technical target, except the mentioned 10,000 base of the triangle level. In Elliott analysis, it is still over 1000 points above its 1998 wave 3/5 high, more than 10%, where as the Nasdaq and S&P are spitting distance from theirs.
In Elliott terms, we have either seen the all time high for the market as a whole or, when this correction is over, the market is going to the moon. The trip to the moon would entail a lot of imagination to reach financially. First of all, people would have to buy back into the idea PE's didn't matter in large cap stocks. PE's don't matter that much in start up companies that have a big time product that is going to have a long term life span, but to give large PE's on companies with cap values in the hundreds of billions is not going to happen again soon. So, if you add inflation to real growth, you might have an 8% figure at best over time. That is the real long term growth potential of the market in general, with winning companies doing better and losing companies doing worse. That is not a bad return if the long bond stays in the 5% range. So, it doesn't bode well for the idea the S&P and Nasdaq could reach significantly higher levels and lends a lot more credence to the idea the market was a bubble and the bubble burst. There are much better assets to own in the world than American stocks, even at current prices. There are only, at best 10 Microsofts in the Nasdaq, including Microsoft and Intel. That gives this market a potential fair value of around $2 to $3 trillion, a far cry from the $8 trillion or so it was valued on the top. Of course, there are only 2 companies of this calibur in the index right now, not 10. A few more like Dell, Oracle and Cisco are getting there and there are a few more prospects, but to predict any of them will earn more than Mr. Softy is going out on a limb.
One thing about this tech market is how much tech is enough? When is your software good enough? A lot of computer sales were predicated on the Windows 2000 release. Seems the 98 version was good enough for a lot of people and 95 is still good enough for quite a few more. Who needs a 1 gig processor right now. I would imagine a minority of people right now and when the game gets to where many people need a 1 gig chip, there will be a 2 gig chip or even a 3 gig chip. 128 meg Ram chips are cheaper than 4 meg chips were 7 years ago when I priced RAM at that time. 20 gig hard drives are cheaper than 800 meg hard drives were 6 years ago. The ability of that industry to generate additional revenue going forward is going to be tough. I think we are going to find the same thing in the internet business, the phone business and the other tech businesses that flew so high on the Nasdaq, meaning a situation where the index could go well past 5000 is not likely in the next few years. The industry in this index is like the auto industry in the first half of the 1900's, where now that everyone has a car, what kind of bells and whistles can everyone not live without? Maybe faster online access necessitates a faster CPU? Are the ones they are making now fast enough? If they are, chances are the ones made in the past couple of years are too, maybe starting with the 500 mhz. That would put my computer on the junk pile, but I can have a 500 mhz chip for about nothing now and a gig will be that cheap when I need one. PC's are plug in and snap together items for the most part and I would venture there are a million kids graduating from high school every year that have the basic knowledge of how to build one from scratch and set one up, though they probably don't know it. That won't do away with companies like Dell because we need those companies to show us what we need to build, but shows how easy it is to compete small time against them.
The primary item that tells me this market is cooked is where we are in the financing business. Real estate prices are starting to skyrocket, which is generally prevalent in the late stages of a mania. Go into town and look at the palaces being built, something that reminds me of the movie, "The Great Gatsby", set in the roaring 20's. Dallas was on a high roll in the mid 1980's, but what is happening now, makes those exhibitions of oppulence look like poor relatives. Just look where I live, an apartment community that was beyond imagination here 15 years ago. Go to Kansas City and you can see an area called The Plaza, that was clearly built in the 1920's era and very elegant. This kind of reminds me of a modern day version of that. Rockefeller Center in NYC was built, just as the bull market came to an end, like the Galleria was started in Houston at the end of the last bull market, at that time the largest mixed use project ever put together in the US. We have in just about every major city in the US, sports palaces being built or recently built and the Yankees are a dynasty again. (They didn't fare as well in the 30's as they did the 20's and except for 76-78, they were non-existant between 1964 and the mid 1990's. Kind of interesting the Yankees are a bull market phenomenon, that fares just a little above average in other times.)
The tech expansion has driven the US economy. It is the trickle up theory, where improvements in this industry, expansion in the industry and so forth has created impetus for the old companies on top. We are rolling around in massive SUV's now, where we were buying small Japanese imports in the 70's and 80's. Even the Japanese have joined that game in the American market. Seems Mercedes almost quit making large cars in the mid 1980's, but now they have a full line from the upper moderate range to the expensive versions. The investment bankers have earned large fees, General Electric has gotten fat in finance fees and we are again spending freely on health care. Much of this has been grown from the tech industry expansion. Thus, if tech is sick, these companies will get sick with it.
It is the debt situation that makes a massive decline likely and the above targets of the 4th wave bottoms not likely to hold. People think of buying stock as investing, but the real investments have already been made. Buying stock is nothing more than trading paper in these already made investments. The paper is no better than the income producing ability of the underlying assets. One might have bought a nice home in Youngstown Ohio in 1975, but that home ended up being a bad buy, though it is as nice as the same home would be in Dallas. Chance are, the mortgage holder foreclosed that home. Did that factor make the investment in that property any worse an investment than the same home in Dallas, at the time? Probably not, as the occupant needed a place to live at the time. Much of the tech investment works the same way in a shifting landscape. If several companies geared up to make semiconductors at the same time, in a good market, they were making the same investment as one was in a home in a market that turned out to be not so good. People may have bought stock in these companies, based upon the investments they thought the companies were making, or they may have been just buying paper in names. Clearly, people have been unaware that companies like Intel have been making impressive gains in technology, massive investments and merely treading water. The tech industry has become like being in heavy traffic on a road with a series of short traffic lights. Seems the time you spend at the front of the line at any given light is short lived, as you go to the next stop and wait about 3 more lights to get to the front. It has become a musical chairs game, and the only way to really win is to pick the company that is going to get the last seat. Somewhere, the efficiency of this business is going to hit a wall, the level of demand is going to level out and the upstart isn't going to have an easy entry into the business. Microsoft was able to do that fairly early in the operating systems business. Intel did fairly well in the CPU business, but they are more vulnerable. Who is going to get the cellphone business? Seems Motorola had it, Nokia is has it now and Qualcom is trying to get it. TI seems to have the DSP business in a big way now, but maybe Intel or AMD or another operation develops something new in that business. And don't forget about the Japanese, as they are subject to garner another large slice of the market, once capital isn't so easy to raise in the US.
The point I am trying to make is there has been massive amounts of debt created to fund the operations and sales of these growing tech operations and much of it is likely to start going bad as it seasons. The unseen risk of lending this capital is about to reveal itself and the next wave will be awhile in coming once the buyers of this debt have to lick their wounds and there are no bigger fools left. This phenomenon is going to show up in the bottom lines of about every major company in America and going to financially impair many, including General Electric. We have already seen the effects hit tech stalwarts Lucent Tech and Xerox. It is going to filter down through the credit card companies and a lot of paper in the money market funds is going bad before this mess is over. We are now supporting over $7 trillion in M-3 with a little over $1 trillion in M-1, a phenomenon Michael pointed out to me yesterday. People are treating the stock market as a savings account and that same M-1 is having to support the stock market as well. For every dollar of M-1 or M-3 there exists a corresponding dollar of debt somewhere. If a major liquidation in debt begins to occur, one cannot make believe these funds in accounts will actually be good and a panic could very well start in the attempt to move from these money market funds to insured accounts. So we are supporting a bridge with a tooth pick and expecting the wind doesn't blow hard enough to upset the balance. Thats about $15 trillion in supposedly liquid assets with $1 trillion in real liquidity, provided the banks assets hold up. Never in history has real liquidity been this thin, except maybe last year at the top of the market.
Then we have the call money situation, which I believe is in peril. Last I saw, there was about $300 billion out there. It is collateralized with paper, but where does the liquidity come from to replace this debt if it is liquidated? I don't believe the money exists on the sidelines and I don't believe new money is coming into the market fast enough to replace it. I have already contended that wall street with its funds managers and brokers is consuming most of the new money being put into mutual funds through its various fees. As the market rose, it provided more and more collateral value to borrow against. It provided leverage to expand this debt. As it has fallen, there is less collateral value and the process will reverse itself. More stock bought by people borrowing more money is going to turn to more stock being sold by people paying back more money and the fuel for higher prices is going to be gone. THE MONEY ON THE SIDELINES IS ALL BORROWED, though maybe not by the people that have it. A sudden shock, which I believe might not be far away, could in essence siphon the money off the sidelines very quickly. We are now in a situation where the amount of debt on margin is about equal to the amount at the top of the market, meaning the debt/equity ratio in the market is now significantly higher and more vulnerable than it was the last time around.
I don't know a lot about where call money comes from, but if it is financed through lines of credit into banks, then M-1 will be affected adversely if there are margin calls. It is the lynchpin to a total collapse in financial liquidity in the United States, as is the threat of the flight of foreign capital from this country. As I watch the yield on the long bond go back up, despite a 1% cut in short term rates, that flight of foreign capital becomes very real. One thing I remember in 1987 was the dollar fell through the floor throughout that year. It seems the long bond hit 7% in March 1987, then rose steadily in yield as the market progressed to the greatest one day crash in history. The yield was over 10% during the week of the crash, as liquidity was leaving the country. We are much more vulnerable to this event today than in 1987, as the US has really taken the role of a modern third world country instead of the declining manufacturing giant it was in 1987. We have purchased the labor of others around the world by mortgaging our property to the hilt and lived like kings in relation to those that provide the labor to make our goods. Instead of selling them the rope to hang us, as Lenin said, China may have sold us the rope to hang us. There is $5 trillion in foreign capital in the US and it is subject to flee when the dollar weakens. It is one reason Greenspan cannot lower rates much more, as is the evidence of inflation. The potential Greenspan and America have been hung out to dry by this asset bubble and debt spiral is in the 90% to 100% range. Our trade deficits are running in the half trillion range now, an amount greater than the GNP in but all be a hand full of nations in the world. This can only be remedied by a drop in consumption or a rise in production and exports. I think the New World Order and its multinational conglomeration has bankrupted the US and we are going to have to have a fire sale at some point. You cut off credit in this country, which eventually has to be done for debt to have any validity, and it implodes. Who wants assets they cannot sell or rent at a cash flow price?
The financial point here is, we are on the Titanic and headed for an iceberg. Only 10% of the iceberg is visible, so to most on board it doesn't look like much of an obsticle. There are some people onboard who know of the massive structure that isn't visible, but to most, the Titanic is supposed to be unsinkable. As the ship brushes against the mass of ice, there is a noise, but the ship is unsinkable! So lets go on the deck and rearrange the furniture a little and get some fresh air. Of course, looking back in history, the ship sank.
I contend we have already hit the iceberg. Greenspan knows we have hit it. I think it was his hope stocks would fall to a level to present a value to foreigners before he cut rates. Recent market action is evidence the ship is sinking, but people still expect Captain Greenspan to come through and bail them out of their bad investments. Then there is the evidence in the debt markets that they too have hit the iceberg, but lets just dilute the bad debt with more debt that won't go bad for a few more quarters. The problem with all this solution is that eventually, one runs out of assets to throw at the problem and the problem starts to consume the assets faster than they are thrown. Then, too late, the masses decide to abandon ship. Of course, many of the lifeboats either spill out empty into the water or are already taken by those that knew the iceberg would probably sink the ship. Safe on shore, the survivors feel grateful they survived, but a little guilty they couldn't rescue the rest. Such is the feeling of a bear in this market.
My contention is Greenspan knew in late 1996 the market had passed reasonable value when he gave his irrational exhuberance speech. The market had an innitial decline, but the band played on and the market reached the sky. Captain Greenspan has been in crisis control almost since then. The mania had already started. It siphoned the liquidity out of the Asian Tigers in 1997 and 1998. Off the 1998 bottom, the unexpected happened and the market, instead of recognizing the danger present, took off for the sky. In a period of a little over a year, the S&P made almost 70% off its bottom. In about 18 months, the Nasdaq gained almost 300% on top of an already highly valued price. There was not an investment penalty for buying into the mania in 1997 and 1998 and the hooks were set for the moral hazard that followed. In the time since then, we have added over $1 trillion to our foreign debt, money that was recycled into the US. (Get our money for nothing, now how do we get our chicks for free). This has been no more than a big orgy played out in the US at the expense of the rest of the world. The new cracks are starting to show, as needed liquidity is now being pulled out of countries like Turkey to support the markets in peril in the industrialized, or should I say first modern world. I expect liquidity in South America and Mexico to be the next to go, just like Mexico fell when the US market ran into the lull in 1994. How many more IMF bailouts are going to be necessary before the whole house of cards falls and the whole world realizes that debt IOU's really mean nothing? When does the US run out of collateral to collateralize the debt of the world and the value of the debt and collateral mean anything in comparison to each other? Greenspan is walking a line between massive inflation and massive deflation and one or the other is going to win this game. Since the house of cards built out of debt is now so fragile, I expect deflation to win out, as least in the short term, as the lefts and rights are coming at Al so fast he can only defend against one at a time. If we don't crater in the next few months, the next move against inflation will do the trick. For those remaining in the market, if it stabilizes from here, the exit signal will be the next rate increase. We have already seen the last successful one, if it turns out to be a success. The jury is still out on that verdict.
We are at the end of a great cycle, if the Elliott wave people are to be believed. What started as an exchange of gold, expanded into an era of lending against gold, which gave way to issuing paper gold, to abandoning gold because the debt could no longer be paid in gold, to the world of make believe that the debt could create the value of the money and could therefore service itself. It seems, that is where the last cycle ended and so it is in the law of nature and mankind. We will probably go back to gold, not because we like it, but because there will be no other choice. Hopefully this doesn't mean another dark age is upon us, like the one that befell Rome at the end of the last major cycle. One must ask, how could civilization and its financing fall apart at such a highly technical time in history? The first major depression in this cycle came in the 1840's, a time that corresponded with self powered locomotion for the first time in history. The telegraph had been invented to deliver messages at long distances, when before messages were limited to how fast and far one could ride a horse or scream. Movement from animal power to the electronic age at that time I contend was a much greater advance in the history of mankind than the internet will ever be, as the internet is just another way to do something that could already be done and more of an upgrade of efficiency than a totally revolutionary invention. Steam locomotion on steel rails as a replacement for carts drawn by horses makes this change pale in comparison. Talking wires instead of messenger service over hundreds of miles makes the upgrades in the new information age look more like a small leap than the quantum leap we think it to be. In between depressions, the electric light, refrigeration, gasoline and diesel powered vehicles, the telephone, television and the radio had been invented and except for the TV were in growing and widespread use in 1929. Transatlantic communication has come into existence. Most of the tech we have today is nothing more than further improvement on these items, the internet being just another use of phone signals. Computer programs have actually put answers into the hands of people that don't possess the knowledge to get the answers otherwise, not necessarily created new knowledge.
Maybe that is the entire backbone of this bull market, tools in the hands of someone that don't know that allows them to think they know. Hundreds of thousands or maybe even millions looking for the same buy signals out of the same software using the same technicals, not knowing a damn thing about what they are buying. What else can explain the detachment from reason that took place in the market the last few years, but people believing answers obtained from a box with buttons on it. Trading with the trend can reach absurdity when the fact that there has been a trend perpetuates itself through a system that follows only the trend, continues the trend and uses no other reason but the trend. In a world such as that, the important items like valuation of assets through earnings, book values, dividends, future possibilites and all the things that give paper assets their values, ceases to matter. Has our technology destroyed the ability of the common man to use his mind and if so, it is not the great panacea we have made it to be, but the very thing that will destroy us? Maybe it already has? |
