Fleck - Market Rap
Cult of Equities Faces Deprogramming by Economy
By Bill Fleckenstein
Special to RealMoney.com
09/10/2003 06:14 PM EDT
URL: thestreet.com
From Modestly to Flamboyantly Red: The foreign markets were slightly lower overnight, as were our futures. After opening modestly red, we sold off 0.5% to 1%, depending on the index, except for the SOX, which shed 3%-plus on lackluster news last night from Texas Instruments (TXN:NYSE) . Housing stocks were drubbed pretty badly, and weakness was also seen in financial stocks, because, lo and behold, turbulence has rattled the mortgage-related/fixed-income markets. In fact, one of my few long positions, Annaly Mortgage (NLY:NYSE) , last night announced the lowering of its dividend, and the stock was down about 15% (more about that below).
Nevertheless, against the backdrop of a market under pressure, I'm sure the bulls were grabbing for their playbook, saying OK, we'll ignore all this weakness, as we have ignored it for many, many months now. However, that offensive formation got blitzed today. After making one swipe at jump-starting the S&P (which the techs never really responded to), the market spent the rest of the afternoon sagging and closed pretty near the lows. Housing stocks were absolutely smashed today for 5%, plus or minus. The SOX was whipped for 6%. Biotechs were under a little pressure as well. Out of all the big speculative leaders, only Internet stocks proved resilient.
Of Rally and Real McCoy: Now the S&P is back to the level it broke out from a little over one week ago. Readers know that I tried to capture this inflection point by shorting the S&P last Friday. I got chased out on Monday, and then today, Wednesday, many stocks saw their first real beating in quite a while. That just goes to show how perverse Mr. Market can be. If the idea that I had was right, I was unable to make it work, because of how tricky the process is. Of course, there's still some chance that this little downdraft is a head-fake. But based on the feel of the tape, I don't think so.
Before the rally started early last winter, stocks didn't really go down "well," except for a couple of weeks. (Obviously, it doesn't take a genius to see that the path of least resistance has been up for quite some time.) Today, however, stocks were heavy all day, something I haven't seen in some time. My suspicion is that the top is in, and I intend to operate as though that's the case. I added to various names on the short side today, and I plan on getting more short in the coming days, as the market allows.
So, my best guess is that we will witness a break, followed by a failing rally. After that failing rally, the serious damage will occur. In the meantime, we may learn a lot more about the near-term direction by observing how the market responds to the next piece of bad news. But remember, all this is pure guesswork.
Away from stocks, fixed income managed a small bounce, while the metals and the euro surrendered a smidgen of yesterday's gains.
Shrug Yields to Sizable Sigh: Turning to the mortgage-related/fixed-income markets for a moment, I have been talking for some time about how problems had to be brewing in the financial arena. My belief that everyone would react at once -- after having long shrugged off all notion of trouble -- appears to be happening, witness the recent headlines from Washington Mutual (WM:NYSE) , National City (NCC:NYSE) and KeyCorp (KEY:NYSE) . As for Annaly Mortgage, the fact that its dividend is now going to be 25 or 30 cents should not come as earth-shattering news. That's what the company has been telegraphing for some time. It expected prepayments to be rapid, and they have been.
Affirmation, Within a Mortgage Statement: I knew, as I am sure others knew, that this would be a quarter in which Annaly didn't make as much, and therefore it wasn't going to pay as much of a dividend. But let's say 25 cents is all they could pay from now on. That would be a $1 dividend on a $19 stock (a $17 stock at yesterday and today's price), still a 5%-plus yield. I happen to think this is the low end of what we're likely to see, and so I am comfortable with that, as I have said many times.
As I have also said, this is a speculative stock. Annaly is engaged in the business of fixed-income management/interest-rate speculation, and it conducts this on a leveraged basis. My view of the company is as a traditional S&L from the old days (with great management), so I am not surprised by its news. I did not have a particularly big position, but as soon as I see the dust settle in the next couple of days, I in fact plan to add to it.
Some might ask, well, if I thought this was coming, why didn't I sell the stock when it was at $20 or $21 at the zenith of the bond market? The truth is, I seriously contemplated doing so on several occasions. However, I made the determination that I would just as soon buy more if it went down. I didn't buy it necessarily for capital gains, but for the income stream, though I don't want or expect to experience a capital loss. Had I been more concerned, more clever or more trading-oriented, I may have sold some. For the many readers who I know have, you are now in a position to "play from strength."
That is my position on Annaly Mortgage. I think it has been stated clearly, so please don't send me any more emails on the subject. (My Q&A site receives more questions about Annaly than anything else except gold stocks.) As I have said over and over, should I change my view, I will make that known in this column.
Manana Mumbo-Jumbo: Meanwhile, I would just make note of yet another very insightful column by Jesse Eisinger in today's Wall Street Journal, "Rolling Downhill," about Nokia (NOK:NYSE) (which kind of disappointed folks yesterday), and Texas Instruments. True to form, he has again made a worthwhile point: "The message from Nokia is: Handset prices are dropping. Since volume was strong, investors assumed cell-phone component makers would be OK. After all, handset volume, not average selling price, matters to component makers. But TI suggests pricing pressure rolls downhill from cell-phone makers to the innards -- manufacturers."
He continues: "The other shot across the bow from TI: operating leverage. Revenue was slightly better than expected, but earnings-per-share forecasts didn't move commensurately. The great promise of tech is the operating leverage, which is supposed to make high P/E multiples melt away when earnings are so much stronger than expected. There's always next quarter."
Risk Included, Batteries Extra: Yes, pricing pressure does roll downhill to the component suppliers, given the excess capacity that has spawned the price wars in most end markets. It is the commodity nature of the technology business, coupled with poor end-market demand, that makes technology valuations problematic and perishable. The stocks come with a tremendous amount of risk, even though they have gone up lately, which of course has only made them more risky, not less.
Folks, of course, like to soothe themselves with thoughts of "Just wait till next quarter. Things will get better." Then they shift the bar to things getting better in the second half, then the following year. We've been playing that game for three years now. It's getting long in the tooth, which is why I believe that when folks discover the economy can't generate a self-sustaining recovery, they're likely to panic.
Beckoning of Equity Reckoning: For now, though, panic takes a backseat to the pursuit of equities. Along those lines, I would like to share an apt quote by James Montier, a global equity strategist at Dresdner Kleinwort Wasserstein, within a story in today's Journal titled "What Will Be Next Bubble to Burst?": "Globally, the biggest bubble is still the whole cult of the equity, that equities have to outperform over the long run." I could not agree more. That mind-set, as well as hope and central-bank recklessness, has retarded the downside of the bubble to a large degree thus far. But with the refi game having ended in the last few months, the moment of truth for the economy will shortly be at hand. At some point, the cult of equity psychology will be tested and, in my opinion, fracture.
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