What a great article. Bear market over? Beware shorts.
CTSL Market Review and Outlook
April 13, 2001
Bear Trap Snaps Shut
Since the last Issue, the Dow Jones Industrial Average gained 328 points or 3.3%. Our CTSL Index soared 8.2%. Nasdaq went up 5 of the last 6 days for a total gain of 7.7%. The bear trap snapped shut.
We are now expecting a capitulation in stock prices based on the issue of a recession. Have we joined the ranks of the bears that have pounded our stocks down far below their true value? Not at all – because we expect capitulation from the bears, not the strong hands (including yours) that now hold technology stocks. The capitulation may have started on April 5th, when some of the bears realized there isn’t going to be a recession to bail them out. NYSE advancing volume was 7x declining volume that day, the highest since March of last year (which was the start of a rally). NASDAQ up volume was 25x declining volume, the highest ever! Combining the two markets, NYSE+NASDAQ advancing volume was 13x declining volume, the highest since the aftermath of the 1987 Crash. The previous higher extreme was reached after the major 1982 bottom, when stocks ran away from the bears for 12 of the next 16 trading days. We remember it with great fondness.
The stock market acts like a pendulum. It gets overpriced, as it was when we went to cash in early 2000 and again last July. Then it corrects down to fair value, which is why we thought we should be buying stocks last September. Sometimes, though, it goes through fair value like a hot knife through butter, and the pendulum swings all the way to undervalued. The recent decline, which was the worst in history, took even the great tech companies to severely undervalued levels.
A bear trap, like a bull trap, is baited with news – in this case, bad news in the form of March quarter earnings. Investors, stung by the 2/3 retracement in Nasdaq (68%) from last March’s high, were busily buying puts and learning how to short stocks. Supposedly responsible newsletter editors and Wall Street gurus paraded through CNBC, pointing out that the dreadful March earnings were sure to set off another leg down in tech stocks. Most of them have been bearish since 1995, totally missed the technology revolution because they don’t understand Moore’s Law, and have been gloating for a year as the Internet bubble burst. We haven’t read such drivel since – well, since Internet "analysts" were forecasting $400 Amazon prices and "eyeballs" replaced earnings as the source of value. We’ve heard the Luddites say that falling prices for technology products are very bad, because they’re deflationary (!), that technology product cycles don’t matter, just what manufacturing is doing (!!), that electronics have not increased productivity at all in the last 15 years (!!!) and that technology will never lead the market up again (!!!!). Plunging costs and dramatic increases in computing and communications power won’t stop for another decade. It’s naive to believe those forces will have little or no effect on the economy and business, or not be reflected in stock prices.
While they’re gloating, they’re forgetting to buy great companies at price/earnings ratios less than their growth rates. The difference between the railroad/steel-based industrial economy or the auto/oil-based consumer economy and the electronics-based economy is Moore’s Law, which will continue for at least another 10 years, driving semiconductor price/performance up another 100x. The processing power that costs $500 per chip today will be $5 then – and the whole world will be wired and computing, using U.S. equipment. What will these nattering nabobs of negativity say when it’s shown that, like a stopped clock, they were right for a moment in time…and forgot to take advantage of it?
Here we want to acknowledge Subodh Kumar of CIBC World Markets, who has been the most bearish of 15 Wall Street strategists surveyed by Bloomberg. Last Tuesday he told investors to boost their portfolios from 55% stocks to 75%. He said: "I’ve had a balanced portfolio for the past couple of years because the risk of a decline in stocks outweighed the potential return. Now, bond yields have bottomed out, cash returns are low and equities are already discounting a recession."
While it’s true he missed the ‘99 runup from 2500 to 5000 because he thought "the risks outweighed the potential returns," at least he hasn’t been bearish for 5 or 10 years like so many of the Cassandras. What’s really impressive is the agile way he went from very bearish to bullish shortly after the market turned. Most of the bears that have been looking for a capitulation by the bulls are now just praying for a down day so they can cover their shorts and get long. The market, of course, is unlikely to accommodate them. Mr. Kumar already made the transition that so many of the current bears will have to, and so many of the permabears won’t be able to. Every convert brings more cash off the sidelines and into the market.
The most important lasting effects of a horrendous experience like the biggest bear market in NASDAQ history are the lessons one learns, as well as avoiding the false lessons others try to put on you. For example, selling anything is always smarter in a bear market. Consequently, you will get all kinds of free advice like "sell anytime a stock breaks its 10 day moving average" or "use firm stop losses at 15% below your purchase price." Any rule like that will improve your bear market performance; most will kill you in a bull market. People have an innate tendency to give too much importance to what happened recently and too little importance to history – which they may not know or understand, anyway.
What we learned from the second half of 2000 was a sinister lesson: the Wall Street tail can now wag the real economy dog. We went to 100% cash early in the year and again before the Microsoft earnings announcement in July, but we went fully invested at the end of August and led you right into an ambush. We thought the strong seasonal fourth quarter/first quarter rally would show up as usual, and the old rule that you buy ‘em at the AEA (American Electronics Association Financial Conference in early November) and sell ‘em at the H&Q (Hambrecht & Quist Technology Conference in early May) would work as usual.
This year, though, a few Wall Street analysts and firms had a different agenda: they undermined the tech sector for personal profit. We’re not crying "foul" because we should have seen it coming, and all’s fair in love and financial war. Jon Joseph of Salomon Smith Barney, Dan Niles of Lehman Brothers and the Merrill Lynch folks ganged up and pulled this off. We will never forget sitting in a meeting with Cymer in November when they told us their business was strong, but they were cutting back inventories because Wall Street was saying bad things were coming. We should have realized that if everyone acted that way, it would be a self-fulfilling prophecy and Wall Street would succeed in creating a bear market in tech.
We’ve been thinking about this recently because Mr. Joseph spent last week traveling around the country with the Salomon sales force telling clients he was "getting ready" to buy the same semiconductor stocks he recommended selling last July. That gives the big money time to take lots of stock away from the little guys at low prices before the formal recommendation comes out, which will run the stocks up sharply. When we started CTSL in 1982, this kind of game played out over many weeks or even a few months. With CNBC and the Internet, it gets flushed into the open in just a few days – but in those few days, the favored clients will get set up for a killing.
At the same time he was "getting ready," he slashed his earnings estimates to "get the bad news on the table" – that is, to knock stocks down. For example, last Friday someone – who could it be? Could it be….Satan? – leaked a story to CNBC that Jon Joseph "might" revise his Intel estimate down. The stock obligingly tumbled $2, leading the Nasdaq Composite to a 65 point decline. On Monday – now here’s a surprise – he cut his Intel estimate from 60 cents to 55 cents for 2001, and from 80 cents to 72 cents for 2002. Although Nasdaq bounced back 25 points that day, INTC remained under pressure and closed down 42 cents. Adding Friday and Monday, 135 million shares of INTC traded. We guess that at least 20 million of those were "real" – sellers getting margin calls, sellers depressed that INTC wasn’t moving up, sellers who believed Dan Niles of Lehman Brothers telling them 2001 is a writeoff, sellers fearful INTC would go through its April 4th closing low of $22.625. We trust the sellers weren’t any of you, because on Wednesday Mr. Joseph said the low prices he had created for Intel and eleven other chip and chip equipment companies looked very attractive and raised his recommendation to "buy." It was a masterfully done manipulation, totally legal, totally unnecessary and should earn him the #1 ranking in the Institutional Investor poll, which was the whole point. The #1 analyst gets signing bonuses, partner status and a mid-seven figure salary. At the same time, he’s led his competitors out on the bearish limb, sat quietly while they became even more bearish – and then sawed off the limb. How can Dan Niles go from "Chip sales down 18% to 20% in 2001…semiconductor stocks will fall another 30% to 50% over the next 6 to 9 months…wait until October to buy" to suddenly recommending the stocks? With INTC already up 24.2% from its low last week, how much pain can he take before he figures out some rationalization to turn bullish?
As for the investors who sold – well, who cares about them?
John Leo, the manager of the $800 million Northern Technology Fund, is one of the favored few who met with Joseph recently. He said of Joseph’s July 2000 call for a semiconductor top: "It was as much gut feel as hard evidence that motivated the move. It doesn’t matter because it was right." He almost certainly gets to vote in the II poll.
Well, we think it does matter. Not only was there no evidence of a top, there was no need for a top. The top was created by Wall Street shaking companies’ confidence, which was expressed as a cutback in inventories, which caused an inventory recession, which cascaded into layoffs, reduced consumer demand and darn near a real recession. When we come out of this and move on, we will see that trendline growth in all technology areas continues, driven by Moore’s Law. This inventory recession will be followed by an inventory recovery, and five years from now the whole experience will look like what it was: an utterly unnecessary dip on the long term trendline. That blip transferred huge amounts of wealth from individuals and 401-K plans to Wall Street insiders and taught Silicon Valley a bitter lesson: Wall Street is jealous of its power and now knows it can control technology by knocking the stocks down and withholding capital from the customers for high tech products. Just as the Justice Department decided to crack the whip over the whole tech sector by taking on Microsoft, Wall Street dealt themselves back into the game by breaking the semiconductor sector.
So what we learned from this experience is the lesson they wanted us to learn: these analysts must be taken seriously, no matter how illogical they are, because they are all-powerful in a world of highly concentrated money management. But we were also reminded of an old country maxim: Never wrestle with a pig. You both get dirty, and the pig enjoys it. Next time we see the pigs coming to take our money away, we’re going to pick up our cards and go home. For now, though, we remain on the most margin ever. |
