The Market Rap: Enron: not big enough to be too big to fail
William A. Fleckenstein
06:00 PM 11|28|2001
While our Euphorians were getting their beauty sleep, Asia was roughed up, surrendering a decent chunk of its gains from Sunday night. The leader on the slide was Korea, down about 6%, but Japan also got into the act, down almost 3%. That spilled over into Europe, which made for a slightly weaker opening. That lower opening turned into a selling squall, with the S&P and the other indices quickly down 1% about an hour into the day. Then we had a straight-up blast of about 1.5% in the S&P and 2% in the Nasdaq, which took us to the morning's highs. At that point, the indices were green, but then we fell right out of bed and went back down to the lows. The sell-off happened at approximately the same time that twin zingers crackled over the tape: Dynegy was going to pull out of its planned Enron purchase, and Enron's debt was cut to junk status. Once not too long ago one of the 10 largest American companies as measured by market cap, Enron saw its stock trade down $3.50 to about $0.60. But of course, unless you've been wandering too long without a hat in the Afghan desert, this should come as no surprise. (Having said that, using the new battle cry that bad news isn't bad news as long as it was "expected," one has to wonder how long the recent glee -- concerning the fact that we are officially in recession so it can't hurt us -- will last.)
The Tip Of The Pipeline After the wild swings in the early going, the market flopped and chopped around for a couple of hours before commencing a steady saw-tooth slide to the lows, which was where we closed. Today, the bank stock index did its best to imitate the Sox. Both were down about 25 points. Of course, that's 5% for the Sox and only 3% for the bank stock index. That said, if this is all there is to the downside for the banks, I would be surprised, as it is hard to believe that Enron is the only live grenade rolling around the floor. Given how big Enron was, one would think there must be counter-party problems in other places. In fact, one of the reasons why I do not like financial stocks is that considering the opaqueness of their accounting, it is nearly impossible to know what their "assets" are.
Laughing Gas Contracts Go Begging Of course, a champion of all this deregulation and financial-company nonsense has been none other than Easy Al. This brings up a question: Since Enron, which was once a mighty large company, has vaporized, is Easy Al out of bullets, and are there more problems soon to follow? I certainly don't know the answer, but I wouldn't be at all surprised to see more fallout than what little bit we have witnessed thus far.
Bulls Gum Funnel Cakes While Bears Note Funnel Clouds Forming Returning to the action, the speculative glow was in essence drained away, at least for today, as the biotech stock index was hit for about 3% and many of the heretofore high-flying speculative cats and dogs came in for a little profit taking. If the rally has seen its zenith, the trap door will open rather quickly in a lot of these names. That said, there have been a handful of one-day declines as the market has rallied in the last six weeks. What we need to see is whether this is just another one of those, or the start of a renewed slide. We should know shortly.
Medallions Of Bull Away from stocks, fixed income again had a bounce, with the five-year up about five eighths of a buck. The euro was up fractionally, as was the yen. Gold and silver were both doing better, with gold up $0.70 and silver up $0.07. About six or eight weeks ago, when gold was trading around $290, I made the point that there would be an opportunity to buy it down in the $270s. I think that moment has arrived. The downside in gold is probably quite limited now, and it makes for a very interesting risk/reward speculation. I also believe that silver has a chance for a decent move to the upside. Whether these turn out to be simply trades or the start of something longer-term, we won't know until the process actually gets under way. As always, I disclose my positions if I hold them: I myself am long silver, some silver calls, and Pan American Silver (PAAS), of which I am also a director. And yesterday, I purchased some gold bullion and more Franco-Nevada warrants.
Sermon On The Newmont It's never been my intention to turn the Rap into a tip sheet, so I tend to mention specific ideas infrequently. However, I have made a point of the fact that a buying opportunity in gold would present itself, and to repeat, I think it's here. People need to find a vehicle that best suits their risk profile, whether it be bullion or securities (or avoiding the ideas altogether). My choice of securities is Franco-Nevada, which is now going to become Newmont. I don't want to divulge a lot of details, because I want people to do their own research, but for those who are willing to put in the time, there are some Franco-Nevada warrants that trade in Toronto that are very interesting. (Please be advised: Trading in these warrants is often "by appointment only.") I like the series that expires in November 2003. If one does the math, one will find that it is a very cheap way to leg into what will ultimately be Newmont "leap" calls. Again, let me say in the interest of full disclosure that I myself own a slug of these. My intention is to keep them for the long term, but I may trade them at some point. In any case, please do not send me e-mails asking for more specifics, because that is specifically what I don't want to do. But I think this is a low-risk juncture that people who have a mind to do something might want to take advantage of.
Unlike Vampires, Scapegoats Can Primp In A Full-Length Mirror In the past and during the mania, I suggested that after people lost their money, they'd be looking for scapegoats. Along those lines, two stories passed on Bloomberg today. One concerns the SEC's investigation into IPO problems surrounding Goldman, Robertson Stephens, JP Morgan, and Morgan Stanley. The other, which is about the related class action lawsuit filed by Milberg Weiss, quotes James Newman, executive director of the research firm Security Class Action Services, as saying that the losses attributable to the alleged fraud are between $10 to $50 billion.
Bull Market In Commissions So, the class action lawyers will be attempting to feed at a pretty big trough. I view this with considerable mixed emotions. On the one hand, I think that Wall Street is guilty of a lot of "scandalous" behavior during the mania, but on the other, individuals behaved fairly irresponsibly on their own. The fact that we are seeing lawsuits was fairly predictable, since it is human nature for people to reject personal responsibility for their own irresponsible actions. And of course, Wall Street is such an inviting target because of the way they played the game. I guess we have a case here of two parties that are in the wrong, and it will fall to the courts to ferret out the lines of culpability. In any case, as I have pointed out in the past, the situation is a potential ticking bomb for some of these financial institutions.
'Every Lump Is Deemed A New Horn' There has been a lot of noise made of the fact that the official declaration of a recession means we must be in a recovery. I have noted my disdain for that. I think it is also interesting that many people who never saw the recession coming are the very same ones squawking the loudest about those claims. When the market was going down and people said that the market was going down anticipating bad economic news, a lot of other people made fun of that, saying, "Oh, the market has anticipated 10 of the last two recessions." Along that same line, a reader sent me an e-mail that I think hits the nail on the head: "Remember just a few months ago when everyone was babbling about how the market had predicted 10 of the last two recessions or some other drivel? Now we hear them say, 'Duh, everybody knew we were in a recession, and the market is discounting the certain recovery in the coming months.' I wonder, how many of the last zero recoveries has the Nikkei predicted in the past dozen years? Also, weren't falling bond yields supposed to be good for stocks just a few weeks ago, but now rising yields are also good for stocks. The bulls live in a Pollyannaish utopia, where every lump is deemed a new horn."
Death And Taxes, Not 'Inevitability,' Are Inevitable My friend Colin sent me a couple of e-mails about people's blind belief in economic recovery and the Fed. As usual, they were both very well written and on point, so I want to share them here. First, Colin writes, "The markets have priced in a complete U.S. economic recovery . . . despite zero substantive evidence of same. The basis for the economic optimism remains what it has been for the last 18 months: inevitability. Fed easing, tax cuts and official rhetoric will induce recovery. Those buying risk assets and selling Treasuries recently figure others who bought earlier, and suffered for it, simply bought too soon. They will be proven horribly wrong. In the market momentum of the moment, there is a huge pressure for portfolio managers to jump on board the rally, independent of fundamentals. This episode of mindless buying will end as all others do -- badly."
Prop Till You Drop Then Colin goes on to discuss why bubbles make for lousy foundations: "The Fed, and other U.S. politicians, still believe the risk asset markets, in particular the stock markets, should be the primary tool of economic policy. They have learned nothing from the experience of recent years. If history teaches us anything, it is that way more often than not, history teaches central banks nothing. Trying to 'float' a post-bubble economy upward on a tide of leveraged or extended (i.e., at absurdly high prices) risk asset speculation has never worked, and will never work for longer than a few months. Such attempts simply lay the foundation for the next and bigger crisis. The Fed is a joke."
Market Wrap is a daily column published by William Fleckenstein. Subscription is $50/year. For subscription info email: Fleckrap@home.com
Disclaimer: William Fleckenstein periodically publishes columns expressing his personal views regarding particular securities, securities market conditions, and personal and institutional investing in general, as well as related subjects.
Mr. Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund in Seattle, Washington. This fund regularly buys, sells, or holds securities that are the subject of his columns, or options with respect to those securities, and regularly holds positions in such securities or options as of the date those columns are published. In particular, this fund regularly holds short positions in such securities as of the date those columns are published. The views and opinions expressed in Mr. Fleckenstein's columns are not intended to constitute a description of the securities bought, sold, or held by the fund. The views and opinions expressed in Mr. Fleckenstein's columns are also not an indication of any intention to buy, sell, or hold any security on behalf of the fund, and investment decisions made on behalf of the fund may change at any time and for any reason. Mr. Fleckenstein's columns are not intended to constitute investment advice or a recommendation to buy, sell, or hold any security. |
