Message in a Bubble Washes Ashore
By Bill Fleckenstein
Index Close Change
Dow 8711.88 +447.49
S&P 500 898.96 +46.12
Nasdaq Composite 1335.25 +73.13
Nasdaq 100 970.13 +59.22
Russell 2000 400.81 +18.55
Semiconductor Index (SOX) 336.83 +21.82
Bank Index 742.26 +47.50
Amex Gold Bugs Index 102.38 +7.38
Dow Transports 2380.95 +126.16
Dow Utilities 219.97 +2.98
NYSE advance-decline +2,086
Nikkei 225 9666.67 +75.64
10-year Treasury Bond 4.53% +0.166
Absence Makes the Format Wander : Today's column is going to be a little different than usual, because there's so much to reprise after my three-week absence. I thought I would share my general view of what's transpired in the marketplace during that time, and then talk a little bit about what may happen going forward. I would also like to review the handful of ideas I've been interested in.
As the World Stomach Turns : While traveling in Europe for the first two weeks, I was struck by the fact that as the S&P and Dow were going down, it was coincident with the world's stock markets generally being under pressure, as though the whole world has recognized that stocks have risk, something that was forgotten in the last five years of the prior millennium. Also, the whole world has apparently discovered that corporate America and Wall Street in general are somewhat less trustworthy than once believed.
Of Rap Columns and Wall Street 'Pillars' : It's worth noting that most of the behavior now coming to light has been knowable for several years. Many, many old Rap columns detail all of these different shenanigans that people are up in arms about now. Granted, I and other fellow skeptics couldn't spell them out in so many words, because without a subpoena, you can never know. In any case, my point is that many of these unsavory activities were a poorly kept secret, and they are therefore not the reason why the market is going down.
For 20/20 Vision, Dab Hindsight with Tincture of Distinction : The market is going down because we are unwinding the bubble, and that is causing everyone to pay attention. Therefore, more stories are being devoted to what seem to be the problem. People have now decided they don't like what generally had received their blessing during the mania, which I think is a big distinction. This is not to minimize the scope of the problem, or to say that many of these revelations are not shocking. Yes, they have caused people to become turned off to stocks, but I think it's very important for everyone to understand that the stock market is not going down on account of them. Our problem is and has been the same thing for a very long time -- the prices of stocks in America got far, far too high in the mania, and even the unwinding we've seen since the peak hasn't completely alleviated that problem.
Of Credit and Conga Lines : Now, as I have mentioned in the past, there are a couple of areas in which stocks are cheap, and I'm sure more values were uncovered in the last decline. However, in the aggregate, I believe stocks are expensive. That's the problem with the stock market. Too many people own stocks at the wrong prices. As to the cause, regular readers will understand that we had a mania courtesy of the complete irresponsibility and incompetence of the Federal Reserve . The mania precipitated under its watch gave human nature the license to go crazy. That license took the form of the problems we are now seeing within Wall Street and corporate America.
Retching from Wretched Excess : So, that is my take on the subject of what is wrong with the stock market. It's simply that we had a mania, stock prices got wildly out of control, we're now correcting those excesses, and we have further to go. By the way, it's not possible to have a mania and expect its aftermath to consist of a short and sweet recession. I still believe that the best economic numbers were seen early in the year, and things will get worse as the year wears on.
The Dollars and Scents of Unchanged SOX : Turning to the past market action for a moment, in the first two weeks that I was gone, the S&P basically dropped about 15%, and I was struck to see that my favorite speculative index, the SOX, was practically unchanged. As we approached last Wednesday, I thought there were a lot of signs that perhaps a low was being established in the Dow and the S&P for a trade, but that seemed inconsistent with the fact that the SOX had held steady during all the surrounding carnage. It seemed impossible to believe that the end of this particular leg of the bear market could occur with people blithely piling into the SOX to capture the upcoming rally.
Reining in Cats, Dogs, and Bulls: On Wednesday, in my fund, we bought some S&P futures against our tech-stock shorts, because of that belief. I could see how the S&P and the Dow could bounce, given what had transpired. But I didn't see how tech could really bounce, because it seemed to have dodged the beating commensurate with what the S&P and the Dow had undergone. Of course on Thursday, Taiwan Semiconductor TSM announced that its capacity utilization was back down to 70%, reined in its bullish outlook, and said it was going to cut its planned capital expenditures.
Hooky-Playing Profits : That meant two things: It kicked the legs out from under the semiconductor-equipment stocks (you know, those "early-cycle winners"), and it also meant that in general, Taiwan did not seem to have a lot of orders on its books for the third-quarter back-to-school tech fantasy that we usually hear about.
For Callused Defeat, Soak SOX in Lager : I'm not sure how high the S&P and the Dow can carry on this bear market rally, but I think that tech, and in particular the SOX, will be a laggard. Many of the companies in technology are the most expensive stocks that I know of. Their fundamentals are terrible. In my opinion, many technology chieftains were the worst offenders in terms of mismanaging their companies' long-run prospects, so as to "make the number" during the mania. Lastly, tech companies will be the most affected by having to expense employee options.
Maybe if the rally that appears to under way can last long enough, tech will have an outside move at the end, but that's somewhere down the road. When this rally ends -- which it will, because it is just a rally and not the bottom, by any stretch -- then everything will resume its decline, I would think, with a good deal of downside yet to come.
Analogy Gone Awol : Last week, I noticed that people were making comparisons to 1973-74, something that I find laughable. I know that people will say the litany of problems we faced then were different, to which I would say, this is because we know what they all were, due to the benefit of hindsight. We don't know all the problems that lie ahead at this particular moment. Valuations are nowhere near what they were then, and I don't believe valuations are anywhere near what they're going to be like when this bear market is finally over, sometime out in the future.
Re-Entry Reveries : Turning to various ideas on the long side, in my own mind I had felt that if there was going to be a decent rally in the stock market, such as the one that may be under way, it would be accompanied by a setback in gold and a setback in the euro. The setback in the euro is in progress, and I myself am looking for a chance to repurchase my euros, as I had sold most of them. When I do, I will make note of this for readers.
Of Pullbacks and Gold Hacks : As for gold, I had said in early April that I thought there would be a correction in gold that would be scary enough to make people doubt the premise of a bull market, and that is in fact what has happened. I think that the current pullback is one to be bought. I'm not quite sure whether gold is going to hold at $300 or take a peek under $300, but I'm watching that closely. In my fund, we bought a tiny amount of gold on Friday. Over the next few days, we are going to feel our way along, in an attempt to build a position, and I will make a note of it when we do so. I would think that would be a wonderful time to buy Newmont Mining NEM , a stock that I happen to own warrants on (in the interest of full disclosure).
Comely Silver Siren : I think that this decline is also a chance to buy silver. Regular readers know my favorite silver stock is Pan American Silver PAAS , of which I happen to be a director and a shareholder, and in which my fund owns stock. It is really a class act in terms of management. It is the single best and the only idea that I feel comfortable with in terms of buying silver. I'm thinking about buying some silver this week, and I will note any such purchase.
Of Continuity and Longing : Turning to two other longs of mine, NLY has had kind of a wild ride in the last few weeks. I have no idea why that's so volatile, but I continue to like it. I also continue to like the debt of Charter Communications CHTR , which was the subject of a story in today's New York Times , though I am no fan of the common. After I mentioned it (specifically, the 4.75 convertibles of 2006), the debt was hit for about 10 points, and traded down to the low $30s. Today, they are priced in the high $30s.
Cable Programming Features Mature Teens . . . : The big problem in cable today is that nobody knows what a cable sub is supposed to be worth, and every cable system is priced differently, based on a group of variables. The Charter Communications senior debt, which sells at about 50 cents on the dollar, was the subject of a very good analysis in last week's Grant's Interest Rate Observer , for those of you who have access to this publication. (The Web site www.grantspub.com . I think it's a very good equity substitute, priced with a yield to maturity in the high teens. I think there's very little chance that it is not money good.
. . . Frolicking on the Convertible : As I pointed out a few weeks back, if the convertibles aren't defaulted on, from here people will get a triple, and they'll be paid about 12% to wait. To repeat, I have absolutely no interest in the common, but if the common were to trade up to $4 or $5, it might be a good short as a hedge against the bonds. Obviously, that adds an element of risk and complicates the idea, but it's food for thought. It should be noted that any time you buy debt at this kind of price, there is always the potential for danger. By definition, this is speculative. So, people who get involved should allocate their money accordingly. It's not for widows and orphans, nor for a huge chunk of anyone's net worth.
Format, Tom, Dick, Harriet, and Rap Readers at Large : That kind of takes care of what's been on my mind. Tomorrow, the Rap will be back to its regular format. In closing, let me just say that I strongly believe this rally is simply a rally. It will need to be sold at some point, because we will see a resumption of the downside down the road. Parenthetically, I might add that the less the rally is believed initially, the longer and higher it's liable to go, but we can just take it on a day-by-day basis going forward.
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