Hype, hope, wishful thinking -- and more hype
By Bill Fleckenstein
The rally unfolding since March is fantasy built on corporate spin and half- truths, foisted on an investing public that's ready to believe. Keep your guard up.
Along the path to successful investing, folks find lots of stumbling blocks. In the self-imposed category, there's hope and denial, which keep investors from understanding financial truths, however unpleasant they may be. Lying in wait to play into that are the big players on Wall Street and corporate America. Their lure is the manipulation of fact, which has been perfected through years of practice.
But with a bit of practice, investors can begin to recognize the manipulation for what it is.
Big Blue's elevator shoes
Last Monday night's earnings announcement from IBM was very interesting, as was the market's response the next day, when IBM closed up 3.5%. Early in the conference call, the company indicated its comfort with estimates for the year. But, as became evident further into the call, it couldn't muster much confidence in the second quarter. In fact, CFO John Joyce basically dodged the issue three times, with one instance that went like this:
Question: "You just indicated, John, that you are comfortable with consensus. I'm assuming you mean the full- year consensus. The clarification is, are you also comfortable with the second-quarter consensus?"
Answer: "OK. First on the full year: Yes, we are comfortable with the full year in that we are on track for the full year. On the second quarter, I just stated that we have a good pipeline of activity. And we are going to be working with our customers to close that business, or as much of that business as we can in the second quarter."
If you're left scratching your head, so were many folks. Actually, when the numbers were torn apart, the "growth" was all from the recent PricewaterhouseCoopers and Rational Software acquisitions, some benefit from currency translation, and other items as well, such as the sale of a facility to Sanmina-SCI and a further $90 million reversal of something else. So, all in all, while the headline says that IBM more or less made the number and is comfortable with its guidance, there was a whole lot of smoke and mirrors. I don't think for a second that IBM can make the second-quarter number or the full-year number. Nevertheless, since I felt that its news wouldn't be bad enough to knock down the stock, I covered my short in it last Monday night. I am now once again without any shorts.
In any case, all I ask out of management is to be honest, and I don't think what IBM did was honest at all. It would be one thing if the company said, "Look, we really don't have a clue, so you guys decide what you think; or, we're just not going to give guidance anymore." But to try to pretend that you're giving some guidance when you're not seems to me to be rather duplicitous.
Face-masking reality
It's sort of like what Novellus Systems said last Monday night on its conference call. The company blamed the fact that people weren't buying semiconductor-capital equipment on SARS (severe acute respiratory syndrome). I mean, give me a break. Hotels might be empty in Asia, and air travel might be curtailed, but nobody cancels orders for semiconductor- capital equipment because of the outbreak of SARS. The company's order guidance saw a huge miss, coming in at about $180 million, vs. expectations of around $240 million. The stock was lower the following Tuesday, but not nearly as weak as one might have expected.
This continued indifference to bad news gives rise to my fear of being short. For the most part, people have been in denial about why we’re having a bear market for about three years now. I have felt that if we got through this earnings season without significant damage done to the tape, the fantasy phase would begin -- sort of the second part of the war rally, following on part one, the relief phase.
Will Tinker Bell ring the opening bell?
While anything is possible. I think we will get a fantasy phase. Folks will say the bad news is behind us and it was all related to the war and SARS and now things will get better. They'll say that Bush has a mandate and that geopolitical concerns are not getting worse, they're getting better. (In my opinion, that happens to be true, by the way.) We will see all kinds of arm- waving about the second half, about how we're not going to be down for four years in a row, after all, and that never fear, the tooth fairy is here and Tinker Bell will ring the NYSE open. If that fantasy phase develops, I think it will provide us with one of the great opportunities of the last few years to take the other side, and that's what I plan to do.
I have thought and been saying since February that we would have a rally around the war, and that it stood a good chance of taking on a life of its own, fueled by all sorts of rationalizations and proclamations. (See my Feb. 24 column, "3 Reasons to Expect a War Rally" and my March 24 column, "Don't Confuse This Rally with a New Bull Market.") I specifically noted before the rally began that, once it got under way, folks would read too much into it. That way, readers could be prepared and not get sucked in by all the hype and hoopla that would likely develop. At this juncture, I don't know how long the rally will continue; it could easily run well into the second quarter. Meanwhile, we must bear in mind that this is a bear-market rally, and things can change rather quickly.
Do not blame the short sellers for this market
You would think that three years after the market peaked, and all the scandals and nonsense that's been uncovered, folks would be interested in placing blame where it's due, rather than trying to find a scapegoat. But the need for a scapegoat remains strong, given the failure of many people to connect the pain of the stock market to the unwinding of the mania. So, some folks seem to think that short sellers, all by themselves, have made certain stocks go lower, which is ridiculous.
Along that line, Jesse Eisinger, who writes the always-worthwhile "Ahead of the Tape" column for The Wall Street Journal, penned a piece last Monday about William Donaldson, our new SEC chairman, and potential changes concerning the regulation of hedge funds. I have looked at some of the proposals, most of which don't seem too onerous. But as Eisinger noted, there appears to be some chatter that this "regulation" is a euphemism for targeting short sellers, the logic of which is naturally absurd. I have written on this topic at length many times, but Eisinger's three-paragraph synopsis was absolutely on point:
"Unfortunately, this seems like a pretext for regulators to target short sellers amid allegations they manipulate markets. On the contrary, short-selling hedge funds -- the majority mostly have their money invested long -- are one of the most effective free-market tools to catch frauds. You could argue that encouraging short selling is an efficient and cost-effective private-sector adjunct to public regulation.
"Surely, some short sellers have done questionable things. But the percentage of short sales compared with the overall volume of trading is minuscule. It is impossible not to notice that the hedge-fund controversies have coincided with our lasting bear market and whining by companies targeted by shorts. These companies bring suspicion only on themselves. Eventually, fundamentals win out; good companies have nothing to fear.
(Let me cut in here: It's been my experience that the greatest whining comes from companies that have something to hide. Back to Eisinger:)
"The odds are so stacked against short selling, it's a wonder anyone does it. The technique exposes you to theoretically unlimited risk. Stocks tend to go up over time. The tax structure disadvantages short-selling capital gains, and it isn't an unregulated practice, either. The 'uptick' rule, whereby you can't short a falling stock, hinders shorting."
Why are these guys AWOL from perp walks?
From that succinct analysis, Eisinger then segued to the mutual-fund industry to make what I would call the most important point: "But it is the mutual-fund managers who were the bubble blowers. They wiped out normal people's riches and have yet to come under serious scrutiny. Despite widespread money-management incompetence, mutual-fund companies haven't changed their practices in the least. Shouldn't the crackdown be focused elsewhere?" I have long asked myself this very question. It's not to say that all mutual funds were guilty of shoddy investment practices, but some certainly were.
Another troubling area for the mutual-fund industry is illiquid positions, which is candidly described by Scott Schoelzel in a recent Wall Street Journal interview ("Janus Twenty's Manager Reflects on His Choices"). Among his problems was the fund’s enormous size; it was as large as $25 billion. "We were … treading in some uncharted water,” Schoelzel said. Plus, he added, “we had these enormous positions that weren't liquid. It was difficult to say, 'Go in and sell 80 million shares of AOL Time Warner.' … Now they are much smaller positions and are at valuations that reflect their current economic outlook."
Pull over on the amass pike?
The point I'd like to emphasize is that mutual funds have been allowed to accumulate these gigantic positions (some of which may comprise 7% to 15% of a company) in the first place, and can make adjustments in them with almost no disclosure requirements -- unlike an individual or an entity, which must "file" with every adjustment in position once any holding reaches 5% of a company.
The sheer size of these positions can tempt the mutual funds to tape-paint - - to force prices absurdly higher in a short space of time. (I'm not saying Janus was guilty in that regard, because I have no idea who actually did it, and without a subpoena, no one will ever know.)
During the mania, I used to complain ad nauseam about all the tape- painting that went on at month's end and quarter's end. The practice remains so blatant, and tolerated, that the talking heads on TV sanitize it with the nice words "window dressing." I am not for creating paperwork, but, given how the large funds are able to amass these positions, perhaps new regulations are in order. For example, the funds could be restricted in their trading activity of stocks where they own over, say, 5%, for the last few days of an accounting period, be it month-end or quarter-end. In any case, tape-painting is the biggest open secret on Wall Street. Certainly, it’s something that the SEC ought to be looking into, if its examination into the investment community is to be comprehensive, rather than just targeted at the hedge fund industry, as Jesse Eisinger pointed out.
By the way, I don't ever recall seeing any ads that say, "You know, we run a giant fund and our liquidity may be hampered because we have these enormously concentrated positions, and hey, if we make a mistake, we may not be able to get out. (And oh, if we keep getting more new money and keep plowing it into the same names, we're potentially marking up positions we already own.)" On the face of it, that should seem obvious to someone who is experienced, but it might not be for someone who is inexperienced. Perhaps the novice investor has the right to be warned of this in advance.
The vermin filter malfunctions
Now on to a recent, related story in the Journal (another about blaming short-sellers) titled "Hedge Fund Finds Dark Side to Message Board," which described the investing branch of the Internet's underbelly. The article recounted a battle between Rocker Partners' Marc Cohodes, a brilliant analyst and short seller, and some anonymous folks on message boards who personally attacked and threatened him. The firm has now sued as many as 17 such investors in the dispute, accusing them of libel and restraint of trade. In the mania, when my column ran on Silicon Investor, I would occasionally visit their message boards related to stocks I’d panned, most notably Gateway. During one visit in the fall of 2000, I laid out the case for what I believed to be unsavory accounting practices. One lunatic accused me of trying to manipulate the stock and said he wanted to report me to the SEC.
I obviously was doing nothing wrong; in fact, it was the company that was doing things wrong. As someone who has been out there frequently criticizing the status quo and things that I thought were incorrect, I myself have gotten a variety of hate mail over the years and had the same experiences that Marc had, although perhaps not to this degree.
In any case, John W. Bartlett, Rocker Partners’ lawyer, made a key point: "We're not saying you can't criticize Rocker Partners, we're saying you can't hide behind anonymity and libel people." Folks who want to use the Internet for investing would be far better off if they just analyzed the negative viewpoints they read, rather than attacking the sources. A lot of people are mighty brave when nobody knows who they are. But I doubt they would behave quite so boorishly if they had to use their real names. |
