The Market Rap
William A. Fleckenstein
06:30 PM 11|29|2001
OPM -- Other People's Money
[The address for the Grant's site had been temporarily changed to www.grantsinvestor.com/site, but its original address has now been restored: grantsinvestor.com. If you just want to read the Rap, you don't have to log in. All you need to do is click on the Rap on the home page and you'll get through. At least that's the way it's set up for now. I also have a new (and I hope permanent) e-mail address ... Given the snafu at @home this weekend, I was not able to retrieve any e-mail from about last Friday through Sunday morning, so any correspondence that you need me to see will have to be re-sent. Hopefully, none of the changes caused anyone too large of an inconvenience.]
Origami Exclusive: Enron's Paper In The Shape Of A Turkey Carcass Overnight, only parts of Asia were strong. Japan was down about 3%, a weakness that I believe relates to bank problems, as well as concerns regarding some of the money funds holding Enron's paper. Europe was weaker as well, as were our stock index futures, but that just spelled a buying opportunity for the revelers in line to place their bets when the casino opened for business. And so they did, as measured by the Sox, which was initially up 1%. My thought was that somebody must have had a hunch about a better-than-expected NAPM number, and in fact that turned out to be right. People were looking for a reading of 42, up from 39.8, and it came in at 44.5. Never mind that this still indicates continuing recession. For the sons and daughters of the American mania, it foretold of blueing skies. So, we had a bit of a rally off that, followed by some choppy action. Then the market fell out of bed and onto the day's lows, which saw the S&P down about 1.25% and the Nasdaq down about 1.5%. This, of course, was followed by an insipid bounce, such that a couple of hours into the day, all the major indices were down just over 1%.
Exposed Light Bulb Goes Off In the early going today, the leader of the slide was the bank stock index, down 2%, as people started to grasp the problems at Enron. I noticed late last week that GE was acting suspiciously poorly, too. Enron was a very large "non-financial," and GE is in essence the same thing. I don't think anyone should be surprised to find out that GE has some exposure. Let me be clear about this: I'm not saying that GE does, because who can know, given the way financial statements are these days? I'm just saying that I wouldn't be shocked. Anyone with a complicated business who was seemingly able to make the numbers be whatever they wanted -- and always throw in a penny better, etc. -- is a potential suspect. GE did just that. So did Cisco. Well look at Cisco now. Yes, it could happen to GE.
Grounded Hogs After we hit the lows in the early going, we spent the next few hours grinding away to the upside, and we hit our day's highs with a couple of hours to go. However, at that point, all the indices were still red. That rally fizzled, and over the rest of the day we slid back closer to the lows of the day. The Nasdaq basically went out on the lows. The S&P and the Dow were slightly off the lows. There is nothing too earth-shaking to report today, and no particular pattern that I could discern. The bank stocks continued to be the weakest. Speculation took it on the chin a bit as the biotech index was down about 4%. The Sox was down about 1.5%. However, Microsoft, which had been weak a bit last week, was green.
Airborne Hogs And then, in the pigs-can-still-fly department, Micron was up about 5% in the hopes that it will be able to merge with Hynix. I'm sure there will be lots of stories bandied about regarding the number-one imagination-driven semiconductor stock. But I can't see how Micron is going to be able to hook up with Hynix, because who is going to swallow the $7 billion in debt? I don't see any way for any kind of a deal to get done, especially when one considers that Hynix was created by the past merger of Hyundai and LG Goldstar. So, if a merger were put together, I can't see how it could possibly be good news. Even if Micron were able to shut down a little bit of capacity, there would be all that debt to deal with. If they issued shares for the debt, there'd be that much more dilution. And at the end of the day, I don't believe that the Korean government is going to let them shut down any plants anyway. I guess it just goes to show that people are still willing to be gullible as long as we talk about something as seemingly exotic as DRAMs, the price of which has only done one thing since they've been invented, which is to collapse. In any case, stay tuned as we follow that bouncing ball.
Away from stocks, the metals were firmer, with gold up 1% and silver up almost 2%. Fixed income was up fractionally. The dollar was up against both the yen and the euro. Oil was up $0.65, surpassing $20 level by nine cents.
Full Fathom Five Thy Portfolio Lies, Of Its Bones Are Enron Made Turning to the news, Gretchen Morgenson once again wrote a wonderful article in the Sunday New York Times: "Beware Those One-Note 401Ks." (Registration required.) It is an eloquent discussion of a point that we have made at various times: the problems with heavily weighting one's 401K with company stock.
Auditory Processing Also in yesterday's Times, Jonathan Glater had an interesting article entitled "Lessons for Auditors in Enron's Collapse." I want to share one particular part of this interview with Lynn Turner, who was formerly the chief accountant for the SEC: Question: "Are there other accounting time bombs, warning signs?" Answer: "Given the way audits have been conducted, more by inquiry than by real investigation in the last few years, we will undoubtedly see more. This is an iceberg and the Titanic just hit it. [The italics are mine.] A study by Andersen last year showed that there were 230 restatements, the majority in the technology industry, but manufacturing was in there as well. That would be something to look for. But I think more than that, I'd encourage investors to look for CEO's or CFO's who are aggressive in their financial reporting and accounting practices, and that's where the time bombs are likely to be." (This is sort of like the point I was just making about companies that always seem to do the impossible, i.e., manage the earnings to just the right spot.) In any case, the interview with Lynn Turner was a good article, and I commend it to readers.
Leper's Colony Turning to today's Wall Street Journal, the story "Deja Vu, Two: How Long Will This Rally Last?" by Ken Brown has a quote that I think illuminates one of the problems with the money management industry and Wall Street today. Speaking about the current environment, Bill Church, the chief investment officer at SG Cowen, says, "It reminds me a little bit of the fourth quarter of 1998, the Fed eased and we were really left in the dust." The article then goes on to say, "One legacy of that period is that money managers are terrified of lagging behind their indexes or the competitors. The risk, of course, is that these managers will be so worried about tailing the indexes that they will follow them down yet again."
Piece Of Cake, And Let Them Eat It And that's exactly what will happen. They will. But they don't think that's a problem. You see, most people believe that if they lose money and everyone else loses money, it's okay. What they're terrified of is having the market go up and then under-performing on the upside. That is what the money management industry has morphed into over the course of the last five or six years, and of course that is wrong. One of the reasons people act this way is because the mutual fund managers, etc., and other forms of money managers often don't worry about losing money. Why worry when your own money is not at risk? It's also why they are willing to waste assets by ramping stocks up. Ladies and gentlemen, in my opinion that is what we saw a great example of late last week. And I believe it's one of the reasons why the market fell straight out of bed this morning.
Nascent Nitwit Also in today's Wall Street Journal, there was a particularly ridiculous Op-Ed article entitled "Enron May Be Dead, But the New Economy Isn't," by Don Tapscott. It just goes to show you that people still believe the wrong things. He says, "The nascent recession makes this retreat to corporate conservatism doubly alluring. Don't be seduced. A siege-like mentality will prove fatal." I disagree with what he says, but one thing I know for sure: Listening to guys like this will definitely prove fatal to investors.
Earth To Larry: Please Call Home Along the same lines of complete and total nonsense, someone forwarded me an article by none other than Larry Kudlow (who never met a rate cut or monetary easing that he didn't like, and is also quite fond of revisionist history). You may know him as the chief economist for Bubblevision. In any case, rather than setting up a link (for a piece that is not worth it), I would like to just reprise a couple of points from "Bubble Busting: It Was the Recession That Vanquished the Technology Boom": "So, the demise of the tech boom was not so much over-investment as it was undergrowth. It was not so much the speculative bubble as it was the collapse of GDP -- down from 9% growth two years ago to the present recessionary contraction. And the blame for that collapse rests squarely with the money managers at the Federal Reserve. Plagued by the idea that the stock market was 'irrationally exuberant,' and the economy 'overheated,' the Fed raised interest rates nine times between mid-1999 and mid-2000 in order to clamp down on the money supply and restrain the boom. . . . The evidence is clear for all to see: Excessive monetary restraint, coupled with rising energy prices, was the chief recessionary culprit -- not a tech bubble."
Does Not Look Good In Tights I once saw Mr. Kudlow make the same statement about the late 1920s and 1930s. He claimed that were it not for a little Fed tightening in 1929, the 1930s wouldn't have turned out as they did. Obviously, Mr. Kudlow cannot recognize a bubble, even when one blows up all around him. He is starting to blame the Fed, but he's doing it for the wrong reason. He criticizes them for a little bit of tightness as opposed to easing, and their raising of the moral hazard.
Putting The Kibosh On Kudlow I did a quick check of Fed fund rate changes this morning, and I wanted to pass along a few facts that people can look at, juxtaposed against Larry's convenient version of fact spinning to support whatever conclusion he likes. In the beginning of 1995, Fed funds were at 5.50%. Though they fluctuated a bit, as of mid-August 1998 they remained at the same level. Next, we had the Long-Term Capital Management debacle, and rates were dropped to 4.75% by the middle of 1999. Then they were bumped back up to 5.50%. Over the course of 2000, we saw rates rise to 6.50%. So, the bottom line is that from the beginning of 1995 and, more importantly, from the middle of August 1998, Fed funds went from 5.50% to 6.50%, a whopping increase of 100 basis points -- not exactly what should have been earth-shaking damage to all that stuff about the "new economy" and "new era." Certainly, no one with an IQ over 40 can believe that a lousy 100 basis points of tightening did all the damage that's been done. And if 100 basis points did so much damage on the upside, how come the 10 rate cuts and over 400 basis-point drop that we've had so far this year haven't alleviated the same?
Whacking Away At the 'Undergrowth' It's very important to understand that it wasn't so much the Fed funds rate that was meaningful or that caused the problem. It was the growth in the money supply (credit creation, if you will) that powered the mania. Even when the Fed was raising rates, money wasn't "tight," since the money supply as measured by M2 was still growing rapidly. To put this in perspective, M2 growth peaked at about 8.5% in early 1999, and then retreated to just under 6% in mid-2000 before rocketing back up to 8% as 2000 ended. To give some meaning to what 6% M2 growth looks like in the context of recent history, that was approximately the peak rate for money growth in 1988, 1990, and 1995.
Restraining Order Placed Against Economist For Abuse Of The Facts In other words, the roughly 6% M2 growth that Kudlow claims was so onerous was the fastest it grew at from 1988 until mid-1998, when it was in the process of screaming back up to 8.5%. What he deems restrictive had previously been as expansive as M2 growth had been in the prior decade -- which is why I say, even when the Fed was raising rates, money was never tight. But I guess the motto of the Bubbleheads must be: never let the facts get in the way of a good story. No, Larry (and everyone else who seems to think that the Fed's little bit of tightening created our problems). Our problems are a function of the massive bubble that went on and was left to grow unchecked for over five years. And our problems will not go away by pretending that something else put us in this predicament. That's why everyone who did not understand the existence of the bubble and that it is the culprit continues to be confused by why things are happening as they are.
Moving Well Below Average On a like vein, there is no new bull market, there's not going to be a new bull market anytime soon, and the economy is not going to get meaningfully better. The sooner people stop tilting at windmills and start behaving responsibly, the better off we will all be. On that score, we could start with CNBC. Last Friday, a reader sent me an e-mail that said, "I was watching CNBC this afternoon and they listed the 90-day new highs. I am familiar with the 52-week highs and lows. I guess next we'll see the 180-day new highs, the 30-day new highs, etc. Funny, I don't seem to recall them talking about the 30-day new lows when the market was going down." Maybe CNBC stands for "Cheerleading, Nothing But Cheerleading!"
Lastly, I have never recommended my own stuff before, but if anyone missed Friday's piece due to the snafu, please be sure and read it, since I came as close to giving investment advice in this Rap as I ever do.
Note to new readers of the Rap: Mr. Fleckenstein often peppers his commentary with an inventive vocabulary known as "fleckisms." All is revealed in the "Insider's Guide to Fleckisms." ...
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.
The views and opinions expressed in Mr. Fleckenstein's columns are his alone ...
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