THE ART OF BECOMING LESS BEARISH (but still a long way from bullish)
FROM CONTRARY INVESTOR
On The Art Of Becoming Less Bearish
Voices From The Lair...As has probably always been the case, we find ourselves involved in two primary functions in
money management. Certainly the overriding and most important action is decision making in the here and now.
Addressing the capital markets as they are on a day-to-day basis while trying to anticipate curves in the landscape directly
ahead. But the second function that is also important from the aspect of surviving to stay in the game longer term is the
process of anticipating what is to come from a much broader or secular viewpoint. As is certainly no big secret to readers
of the past three years, we've been pretty darn bearish on what we believed was one of the more extreme market
environments ever witnessed in US financial history. Bearish from the standpoint of hoping to see the environment for
what it was (and continues to be) on a near term factual basis and reacting accordingly. You've had to put up with our
philosophical meanderings regarding the concept of non-linearity. Our thoughts on the social nature and dynamics of
group decision making. Our understanding of the macro supply and demand dynamics that can act to put pressure on
and shape financial asset prices over short periods of time.
Maybe this is more for ourselves than not, but we hope it is worthwhile to take a few minutes away from the rather
unpleasant facts of the moment and force ourselves to examine "the other side of the equation". What we hope to explore
is the process of becoming less bearish. Let us draw a specific distinction here. We did not say becoming outright
bullish. Less bearish is a process we believe we need to personally address as price destruction continues and
confidence destruction is now happening around us on a daily basis. It is out in the open. Front page of the popular
media. Headlines like "The Betrayed Investor" as a Business Week cover. "The Sadness of Japan" as a cover of the
ever-thoughtful Economist. "Hot Stocks To Avoid" as a headline article in the recent Forbes. The sins of corporate
America as well as sell side analysts and strategists openly addressed on the now declining in ratings CNBC.
Accounting issues no longer relegated to exploration and exposure strictly among the bearish underground. God forbid
that it is now becoming popular to be bearish! What's a poor bear to do? Join the growing chorus? After all, we've
already been singing the same tune for years and know the chorus and melody by heart.
As you've heard us mention a million times now, bear markets are a process of confidence destruction. The mirror
image of the group oriented confidence buildup that is a bull market. As with any type of human decision making, there is
never any certainty or ability to pinpoint exactly where we are in either cycle of directional confidence at any point in time.
Did anyone really have ultimate certainty that March of 2000 was the top for the former bull both in price and perception?
Of course not. Just as no one will be able to pick the ultimate bottom in time or price. March of 2000 was nothing but
blue sky's. Not a problem cloud in sight for the herd. In today's world of 24 short months later, storm clouds have
gathered and true factual blue is only seen in patches, if at all. Folks like John Templeton have spoken about points of
maximum optimism (bullishness) and maximum pessimism (bearishness) in market cycles. Elegant in concept, but an
art to capture in day-to-day financial asset management.
I See A Red Door And I Want It Painted Black...So what do we know and what don't we know about where we are in the
process of confidence destruction? In the process that will hopefully encompass becoming less bearish as the crowd
becomes more bearish.
The first thing we do know is that the world coming to an end is a low probability bet. At least so far from a historical
standpoint. If it happens, who will really give a damn about the personal portfolio or 401(k) account anyway? Anecdotally,
Tim recently mentioned to us that, "At 1000 on the NAZ, I'm a buyer. At 750 on the NAZ, I'm a buyer. At 500 on the NAZ, I'm
a buyer. Below 500? I get a gun, ammo, food and religion." Enough said?
The public love affair with equities is decelerating on a rate of change basis. 2001 was the lowest inflow to equity
mutual funds in ten years. Our entire January Monthly Market Observations piece was dedicated to this phenomenon.
We do know that the public is disenchanted enough to have slowed equity fund purchases dramatically. Confidence has
surely been negatively influenced by market events of the last two years. The data is in plain view. Within the analysis of
the process of confidence destruction, the key question ahead is "will the public become disenchanted enough to sell?"
Regardless of price? At the moment, that is an unknown and a serious risk to forward price.
The phenomenon of the credit bubble is being reconciled one tiny step at a time. Clearly we are still a long way from
the endgame in this process. Miles away. But, as you know, the recent bond rating agency witch hunt is in full force on
the corporate side of the equation. A process that should have been initiated years ago. Is it really that corporate
managements have recently decided to initiate questionable accounting practices in the last few months (post the ENE
debacle)? Of course not. It's been going on for years and is now gaining momentum in terms of recognition and
adjustment in terms of asset price - both stocks and bonds.
Is every corporation out there guilty of criminal accounting activity, investor deception and fraud? Surely not. But for a
while, the media would have you believe as much. (It sells copy.) The media has become enchanted with attempting to
identify the "next Enron". Chances are there will be a few more, but it will be far from a 100% clean sweep of the NYSE.
The fact is that to the best of its ability, the commercial paper market has been addressing financial asset quality
deterioration for a number of years now. It just has not been front page news until now:
Same deal on the bank lending side of the equation. Although a number of headline banks have recently been put on the
hook for some serious additions to the loan portfolio resulting from recently activated credit lines they extended years
ago, the rate of deceleration in bank lending into the commercial and industrial complex over the last few years is one of
the worst year over year rates of change in three decades at least:
Make no mistake about it, leverage is a huge roadblock to future economic growth and financial health in this country.
There exists a certain probability that it tips us into economic circumstances we'd rather not contemplate. It probably tops
our list of worries. The GSE's, derivatives, structured finance, synthetic leases, SPE's and SPV's, etc. are all finally
floating to the surface as issues of importance. As you know, the data on the serious nature of the credit bubble has
been there all along. The fact that it is now slowly finding its way into the mainstream is a sign that the process of
confidence and price destruction is right on historical schedule. It is accelerating just as it should as the process of
attempting to correct excesses of historical proportions plays out. Problems solved just because they are being realized
by a wider audience? Not by a long shot.
The current focus and reconciliation surrounds corporate balance sheets. The GSE's continue to profligate as we speak,
although the questioning voices being raised concerning these expansionists are receiving more prominent media
attention. Consumer leverage remains an unresolved and serious issue. Consumer balance sheet expansion during
this recession is virtually without precedent for a recessionary cycle. As we mentioned, the current credit reconciliation is
occurring in pockets and is far from complete. The process of confidence destruction regarding system wide leverage is
currently a sniper attack, not a full assualt. But, possibly the key to current activity is that it is being taken seriously in the
mainstream as opposed to being laughed off or dismissed as was the case just a short while ago. That is incremental
change. A reason to turn bullish? Hardly. But possibly a reason to become less bearish as recognition and
reconciliation certainly accelerate ahead.
Asset price destruction and current asset valuations remain an issue likewise unresolved for now. For what it is
worth, by the time this issue is resolved, it's a good bet that the price lows will have been seen. As you know, we have
ranted and raved about valuations for years. We just ripped the SOX apart last week. By no means are we trying to
placate the significant lack of current resolution that remains in place right now. In exploring the "other side of the
equation" and in trying to teach ourselves to be open to the concept of becoming less bearish over time, we need to
remember that bear market lows are made in blackness, not in sunshine. Not in earnings turnarounds. Not in
accelerating rate of change, but rather in the depths of rate of change deceleration. Lows are made in hopelessness.
They are made when individual investors swear off stocks forever. Clearly, we are not there yet, but the worse conditions
become, the more we have to reinforce in ourselves flexibility and balance.
For what it is worth, in the following charts, we update historical comparative asset manias and their aftermaths. There
will be no one for one repeats. Just conceptual similarities in human reaction and decision making:
If the NASDAQ bubble reconciles as did the Dow during the 1930's, it is not out of the question at all that somewhere near
500 will be the bottom. Just how many folks do you believe will have the psychological resolve to back up the truck at that
level? We can only hope to have the emotional maturity to throw her into reverse and open the loading gate at that point,
all else being equal.
As per the model of the Japanese bubble, the NASDAQ may have already seen its lows for the next eight or nine years.
Of course, that is not saying much about upside potential. One just never knows how bubble reconciliation will play out in
exact format. As you know, we have strongly suggested and are working under the trading range (and a moving range at
that) format for the time being.
Moreover, the NASDAQ has been the poster child for stock price destruction during this cycle. As it should be given that
most of the hope and dream fluff balls were NASDAQ listed securities this go around. The S&P 500 having given proper
weight to many a new era dream machine has been hurt to the tune of what has been historically average bear market
mangling, at least up to this point. Unlike its two compadres, the Dow has largely escaped hard core damage throughout
the current bear cycle. The Dow and S&P just may be where the final acts of this bear eventually play out. It's a darn good
bet that a lot of institutional money has migrated from arrogant NASDAQ exposure to seeking shelter from the storm in
S&P participation, to outright hiding in the Dow at the moment. As you know, at least as witnessed during most historical
interludes of ursine character, one can run, but never hide. The bear eventually captures all players in the game of
financial hide and go seek, but as is clear, the game is already well underway. Match point? Not yet.
In the attempt to become comfortable with the process of becoming less bearish, we guarantee that time and price (of a
bottom) will elude all players. Don't even attempt to believe otherwise. As we have mentioned to you in prior missives,
Wall Street's graveyards are littered with those who were exactly correct...too early. No betting the directional ranch at any
points in time. One acre by one acre. Becoming less bearish will most assuredly be an incremental process for us. And
at the moment, we're in the thinking stage.
Many foreign markets are a mess. Japan may end up being a financial nuclear bomb whose fallout descends a
deflationary toxic financial rain across the planet. The final act has yet to play out. Argentina ruined by debt. Venezuela
the next blow up (a relative term)? As we mentioned a few discussions back, the unwinding of global leverage has been
a serious problem for over half a decade now at least. It's just that currently it seems so much more important because
the leverage bonfire has hit the States. Welcome to the global club, folks.
To us, it sounds a bit too contrite to say that the Japanese situation is so well known and documented that "it's already in
the price". The law of unintended consequences can often exert itself at the most inopportune of times. Last week we
had lunch with a good friend of ours who runs a global strategy service for institutional investors. He has a large
Japanese institutional client base. What he is hearing is that there will be a crisis event or series of events soon. His
clients are telling him that it is their perception that the factious nature of Japanese government/politics is precluding
serious reform. Only a significant crisis will allow a unified consensus for action (reflation and bank bailouts w/public
money). Allowing a few big banks and/or construction firms to fail would probably do the trick. Who knows what is to
come, but this was what he was hearing from the Japanese institutional crowd. If something like this were to occur, do
you believe the perceptual process of confidence destruction among US financial market participants would accelerate or
decelerate?
Is it a mere coincidence that the Japanese experience of the last 18 years and the like experience of the US during the
1920's and 30's is so similar point to point as seen in the chart above? We have the feeling that we are about to find out
very soon. Although this may be one fatal statement, a lot of bad news has been impounded in the price of foreign
market assets. At this point, who doesn't know that Japan is a financial basket case? A crisis event or series of events
just may precipitate real reform and a milestone low in prices ahead. If not, we probably witness Japan eventually
repatriate global capital and send the planet into a depression. The ultimate Japanese import, or re-import as the case
may be.
Enron is the poster child for the end of an era. The possible end of an era of aggressive financial transactions and
accounting presentation. The end of an era of implicitly trusting Wall Street, corporate communications, the accounting
profession and the legal community. Have we left anyone out? Oh yeah, the politicians too. Just for good measure. As
we detailed to you in number form last week, dollar losses at Enron are simply dwarfed by the market cap contraction of
tech and big cap S&P over the last few years. Every bear market needs a defining moment. A defining perceptual event.
Enron is our moment. Enron is our event, even if the dollar loss was 1/6th the top to current market cap loss in Cisco
alone.
Legislative hearings. Talk of legislative 401(k) and retirement plan reform. The recent introduction of legislation to force
companies to address the economic realities of stock options on their P&L's. Just today, the International Accounting
Standards Board (based in London) called for stock options to be expensed on P&L's. Maybe that's why Silicon Valley
bars were packed this evening with tech CEO's and CFO's mumbling to themselves. Government pounding their chests
and slapping the hands of bad boy corporate America. This is just what we want to see in terms of a catalyst for
incremental change. Both in terms of real reforms as well as investor perceptions. Once again, all the problems solved
and away we go into the next bull market? Not on your life. Not for a good while yet. The positive here is the recognition
and attention to the fact that something is wrong. Investor's confidence has been misplaced during the new era. Bear
markets die in the depths of mistrust. The process of instilling populist mistrust has just begun.
In terms of reform, our guess is that it will come from within as well as from without (the government). Auditing firms
know that their financial behinds are now on the line with each audit sign off. Like never before during the new era.
Likewise law firms. Likewise Wall Street houses "selling" corporate financial "transactions", SPE's, SPV's, etc. The
potential full employment act for the trial lawyer community has arrived. Who needs asbestos when financial fodder such
as potential liability of constituent parties to Enron has been laid at their feet? Constituent parties such as the auditing
crowd will most likely stop bending over for corporate managements. The fees they earn for auditing may pale in
comparison to potentially having to get their attorneys to fire up their word processors in terms of future litigation
possibilities. Lastly, corporate management's have a certain incentive to clean up sooner rather than later. Although it's
often easy at the corporate level to buy into the "we'll have this fixed in just a quarter or two" mentality, being caught in
questionable activity well after the herd has either fessed up or been "outed" will not be a pleasant experience. The
write-offs, reduction in expected earnings, and other clean up actions will take place starting now. Do you think this
raises or lowers expected S&P earnings for the year?
We don't mean to ramble, but just wanted to get ourselves and readers to at least address the negativity that is
emerging. The problems now around us are what the bears have been ranting and raving about for years. Have been
hoping for. It's what we have tried to factually present for some time. It is coming to fruition before our eyes. Not
necessarily in asset price everyday, but in fact. Again, we reiterate that the process of becoming less bearish has nothing
to do with rushing out and buying stocks. It has nothing to do with planting the bullish flag in the soil at a specific time
and price point. It has to do with being open to alternative paths of thought. It has to do with slowly walking away from the
crowd as/if the crowd becomes increasingly bearish. Will any of this help you at the open of the market tomorrow?
Certainly not. This is about a tomorrow that might just be measured in years. We fully expect some of this current
conceptual banter to become examples in fact as time passes. As contrarians, we're counting on it. Don't worry. On
Thursday, back to the factual matters at hand.
A Prisoner Of The White Lines On The Freeway...Keep your eyes on the road and your hands upon the wheel. Tim
graciously presents a roadmap for the S&P below. The channel is so well defined that a sustained break in either
direction should be incredibly meaningful. As you know, the recent past has been one of the longest periods of "hugging
the line" since late 2000. A bear hug, or something different? |
