Dave--
Very interesting question and thread discussion: I think it is extremely important to think through these questions, as they help us define the trading context we're operating in. Here are a few thoughts.
(1) The essential market phenomenon we're seeing is the unwinding of massive positions in technology. During the fall, I posted a number of times on my suspicion that the day-after-day distribution had to be coming from the huge mutual funds that had accumulated, in some cases, hundreds of millions of shares of certain large-cap technology stocks. When Fidelity, Janus, and the like decide to restructure their portfolios, that has an enormous impact on the market, because they're moving tremendous amounts of capital. A few days ago, I read an article on TheStreet.com that picked up on this theme: it noted that Janus owned something like 267 million shares of NOK, and that they have been trying to sell down this position in the weakened environment after NOK's recent warning. It quoted an analyst who asked precisely the right question: "Who's the buyer of last resort for 270 million shares of NOK?" Who, indeed?! It's just not possible to diversify out of massive, overweighted positions like this overnight -- especially in a market environment that's this paranoid. It can take months, even years, to burn these large holdings down; and I think that's something we are seeing right now. That's one reason the tech market has this relentless feel to it, because the same funds that bought techs every day, for years, are now selling them every single day. This is also a reason I'm suspicious of the idea that a classical capitulation day will mark a definitive bottom for this market: we're looking at sustained patterns of selling in immense positions that aren't going to be sold down all in one day, or even one week, of massive volume. These kinds of high-volume days might mark tradable reversals, but I think the excesses of the Nasdaq had become so great that we'll need a significant period of downward grinding before there's enough inventory clearance to take the relentless selling pressure off the market.
(2) The essential economic phenomenon we're witnessing is a sharp, sudden slowdown that was largely unanticipated. We have to accept this fact, because it completely changes the psychology of the market, and particularly the growth areas within the market. The key fact is that this slowdown was unexpected: just a few months ago, we still put enormous year-over-year and long-term growth numbers out across the board for technology. Now, almost overnight, we're in an environment where INTC will see at least a 10-15 percent sequential decline in sales. That's astonishing, and we simply must be open to the consequences of this. Among investors, these psychological changes tend to manifest themselves in a fairly mechanical way, through the calculus of "valuation" -- the devastating phenomenon of multiple compression. Consider a hypothetical company with projected EPS of 1.00, projected long-term growth rate of 30 percent, and P/E of 90 (which implies a premium to growth rate, or P/E/G, of 3). This stock will trade at 90. But then say its EPS is reduced to 0.50 and its long-term growth rate is trimmed to 15. Because its growth rate is slowing, let's say the market becomes less willing to pay up for growth, giving a P/E of 30 (P/E/G of 2). The stock will now trade at 15. In other words, the mechanism of re-valuation will take this hypothetical stock down by more than 83 percent. This may be an "overreaction" on the market's part, but the basic logic of re-valuation is fairly clear and illustrates how devastating a dramatic recasting of growth expectations can be. Certainly the charts of stocks like JDSU, CSCO, and YHOO show how painful our psychological adjustments can be.
(3) You certainly are right that we see profit-taking come into the market very quickly. I think there are a variety of good reasons for this. One, on a fundamental basis, we all know now that the economic environment is challenging, and so we're understandably nervous about that fact. Two, the market is clearly trending downward, in alignment with the deterioration in the real economy. This heightens the risks for anyone who waits too long to take profits on the long side: when the trend is down, why establish long-term positions on the long side? Three, and most importantly, all traders in the market essentially have access to live, real-time market information. Here I don't primarily mean access to news and company fundamentals. Instead, I mean access to order flow: Level II lets everyone in the market see who's doing what. We can see instantaneously when a large player shows up to buy or sell, and we can get in ahead of that player and piggyback. The net effect is to make it technologically possible for everyone to try and scalp the market. And many, many players are doing just that, from hot-money hedgies to small-timers players like those of us on SI. The technological capacity to scalp and the nervousness surrounding the real economy have clearly been reinforcing one another: the economy gives people a desire to scalp, the technological access to order flow gives people the ability to scalp -- and here we are. I really don't see this changing until the market regains confidence and reverses its downward trend pattern. The incentive to trade, rather than invest, is just too great when the economy and market contain the levels of risk that we are suffering today.
In direct answer to your primary question: I would say that daytraders are contributing to the breakdown of the market, but I think there would nonetheless be a downward bias as the big-money sells down its overweighted positions in the tech sector. If anything, I suspect the daytraders (hedge funds and retail traders) are ultimately helping the large funds sell down their positions: they provide liquidity in areas of the market that otherwise would have few buyers right now. The volatility is nerve-wracking. The quick profit-taking (or loss-dumping or short-selling) frustrates hopes that we will establish upside momentum. But these are near-term issues that probably are offset by the long-term benefit they provide by adding liquidity and helping the mutuals dump their unwanted inventory.
One final thought for now: I think it's going to be very, very difficult to restore long-term confidence in the tech sector right now. The Nasdaq is down some 60 percent in just 12 months. I think that fact is really just sinking in, for the first time, right now. The Dow and S&P have performed so well that the Nasdaq hasn't created much of a sense of urgency until just recently. A 60 percent decline in one year! That's incredible -- and scary. And that's what this market is just now starting to discover. There will come a day when we can settle in for some longer-term holds in tech and ride them up, but I don't plan to be the first player to make that bet. |
