The Bearish Case:
Be honest: would you be shocked if it's all over now? If the Amazon.coms and their "we'll make money someday, now buzz off" business model never again soars to $30 billion, would you think it unfair? If the endless stream of 22-year-old IPO multi-millionaires dries up, will you shake your fist at the sky and plaintively wail, "Why, oh, why, dear Lord, are you going to force these people back to serving me latte before they all become independently wealthy?" If the market pulled a Jean Van de Velde and collapsed here, would our grandchildren be any kinder in their assessment of our cool, rational market valuations and assumptions than we are of the 1920s, the go-go 1960s, or even the Dutch and their tulips? I doubt it.
I'm not turning into Abelson on you or anything. I still love tech, the bull market, and Greed.com. But I've been through this late summer thing the last couple of years. However benign it begins, it ends with you wondering if it felt like this in December of 1972, when the Dow topped at 1020 before sliding to the high 500s over the next two years. If that's the case, even with the schnide of the last couple of weeks, the getting is still relatively good, because we've got a lot of selling yet to come.
I can't remember the last time I had this same bearish, queasy, short-it-all-and-let-God-sort-it-out feeling, but I'm guessing it was last year starting about now, and lasting (too long) until November. I went too bearish then, and spent the end of the year in a most non-relaxing manner making up for it. Looking back, that was at least in part because I operated too instinctively, and not off quantifiable and specific concerns. I let the inner Thug-Warrior take the reins, and he went too aggressively short. In the interest of separating myself from my bulldog, with her mysterious and persistent fear of bags, I'm going to attempt to demonstrate the capacity for learning by not making the same mistakes again. I'm spending a lot of time discussing, listing, and itemizing specifically what it is about the current market that concerns me.
It's a hassle to elaborate on the bear case when you just want the selling to disappear, but it's better to do it now, while you can go through the exercise rationally. If you wait for some later date with S&P futures down lock-limit, and Barton Biggs superimposing graphs of the Dow in 1929, the Nikkei in 1988, and our market at that exact moment, it becomes harder to assess positions long and short with a clear head.
What's wrong with the market?
Valuations. Still stink. 5% to 10% off the top, they are still absurdly high from a historical perspective. There are three ways to reconcile this. First, this is a one-time adjustment in what we are willing to pay for stocks. I'm just the messenger on this, but there are those that claim that the market has basically been "wrong" for the last 100 years, and stocks, as represented by the Dow, are worth four or five times more than the 20-times earnings or so we've been paying historically. In this case, we reconcile it by continuing to go up for a few years. This has a slight chance of coming to pass if you have no inflation and low, low, super-duper low rates (see below).
Second, we can bide time while the companies grown into their valuations. This would require that the world remain a wonderful place to be an American conglomerate for at least the next 10 years or so. Could happen, I suppose.
Finally, we could just lop 20% to 30% off the top of this sucker and rebuild from there. This seems the most logical, but smarter people than I have gone bust waiting for that to happen since at least 1995.
The economy. If we're not out of the sweet spot yet, we're probably getting there. Yeah, yeah, yeah, the Internet changes everything. Goods become cheaper while costs go down, and starting salaries are $100,000 for anything you want to do. As long as the only things you buy online are plane tickets and computers, that's true. Of course, if you can't drive your computer and sleep on a plane forever like Charlie on MTA, you're screwed.
The data coming out is telling us that prices are rising and the economy is chugging along briskly. Logically, but painfully, the Fed seems to have switched from a neutral stance to possibly raising rates again at the end of the month. Greenspan's marginally hawkish testimony on the heels of going neutral was like the prom queen telling us that she meant she loved us as a friend just after we dropped three bills taking her out to dinner. You just wanted to get back all the money you'd spent and go home.
Don't give me the intellectual mush-ball argument that the Nets don't borrow cash, so rates don't affect them. If I'm going to pay 100 times for a dollar you're promising to earn in five years, that dollar had better not be getting hammered by inflation. Inflation kills everything in its wake, and the first thing to go will be the market as the cost of money rises. Think you can fight the Fed's hikes? Hold a seance and ask anyone that's tried to be short since last October.
Love him or hate him, you must always remember that the Fed Chair long ago replaced Mike Tyson as the baddest man on the planet. Never, ever, fight the Fed.
The graphs. I'm not a chartist per se, but the technical action of the market lately illustrates several larger problems that are of concern. Specifically, the market and individual stocks that I follow persistently fail as they reach their old highs. For the market to go up, the marginal buyer of stocks needs to be willing to pay more than the buyers that preceded him. The exact opposite is happening: in just about every former leadership group, the marginal seller is willing to accept less for his stock than the sellers that came before him. If you want a graphic representation of a Whack-a-Mole, punch up eBay (EBAY) since April. I don't get paid to try and time the moment when such death spirals may reverse.
You can pick your own technical indicator - new highs versus new lows, advance-decline, whatever pattern you want. I don't see any that look good yet.
Sentiment. Still too bullish out there. No one seems to be calling it a bottom yet, but if I read or hear the phrase, "Concerned for the short term but looking for Dow 12,000" or its variants one more time, I'm throwing my PC through my television. Granted, that's an improvement over the first week after the largest all-time sell-off, where the selling was attributed solely to "summer," but it's still not where we need to be to get a sustained bounce. I want to see more people carping about the market, more whine-sheets like this. If not more fear, I want to see more healthy respect for the pure power of a market sell-off and its ability to stop even the heartiest of YTD returns.
Unknown. Anyone who saw Long Term Capital Management nearly topple the global markets last year has hopefully developed a healthy respect for the great unknown. As boxers will tell you, it's the punches you don't see coming that will knock you out. Into this I lump Asian and Latin American concerns, the specific effects of Y2K, and all things, well, unknown. This year, as last, the market seems to be groping for a reason to stay at lofty levels achieved in the first half; in this state, it is extremely susceptible to things it can't see coming. Anybody that tells you they know the exact ramifications of Y2K, for instance, is selling you something.
My game plan
I can already see the hate mail piling up on this column, as it does every time I'm critical of the market. Again, I hasten to remind you that I'm really not trying to convince you of anything, I'm just reporting what I see. I want to be bullish, and if anything, err more frequently on the side of too much belief in the stocks. But this market is just ugly and painful right now for me to wax Pollyanna for you. The reasons to be bearish are stacked up like planes waiting to land at O'Hare. To make matters worse, you have an IPO slate that just screams market top; increasing supply even as demand for existing stocks wanes. You can draw your own graph to guess what happens to the price level.
So what am I doing about it? Despite the coming accusations, I'm not shorting everything that moves. It's much easier to make money long than it is short. When you're short, squeezes kill you, puts are absurdly expensive, and your straight short upside is capped at 100%. Further, there is a big difference between being generally bearish, which I am, and calling for a sharp, fast correction or crash, which I'm not. Tell me that the market is going to move 25% tomorrow, and I'll be retired in two days. The market is more complicated than that. I continue to use any strength to add to cash positions. (Judging by the way the market rolled over as I wrote this column on Monday, I'm not the only one doing this.) The longs that I'm keeping are being offset with shorts in the same sector and indices.
Mostly, I continue to hang out in cash, an enormously comfortable place to be in a market decline. More actively, I'm tracking the above list, waiting for those and other factors to play themselves out one way or the other. If they become even more worrisome, I'll lean further to the short side. If they fall in favor of the bulls, I'll lean more long. When the market seems to whipsaw over a percentage point a day, the temptation is to take massive positions short and long and to get caught in the sentiment of the moment. Before I'm comfortable adding to my long positions, keeping a list of macro issues that I need to see resolved helps keep my eye on the ball in the bearish dog days of summer.
If the market makes a bottom without me, the braver souls buying now deserve the extra money for being smarter than I am. On the other hand, if this is the start of something really grim, well, it's better to have money to buy in a panic than it is to have to sell.
ragingbull.com |
