Don Hays Market Comment
December 20, 1999
Tomorrow's the big day, and what a party it should be. Alan Greenspan
will be the host as he brings together all his elves, and never before in
history has any Santa Claus done more to bring so many toys to all those
greedy little boys and girls. We are embarrassed to report that the toys
seem to be more the "blow-up" type, full of air and vulnerable to being
burst, but that is evidently a story that will have to be proved.
I am almost embarrassed to talk about the fragility of those toys. Being
a grinch is not that much fun, especially when it seems that the boys and
girls are having so much fun, running excitedly from one toy box to the
next. And there certainly is not a lot of originality in my tales of doom
and gloom. It is almost like the market keeps giving us enough ugly signs
to keep us from joining the party.
My trip to Boston and New York last week was more of the same. I have
been fortunate enough in the last 15 years of giving these presentations,
that I now have the pleasure of meeting with some of the most accomplished
money managers that have earned their stripes in the last 20 years. I am
sorry to report, however that all of these ladies and gentlemen are over
the age--physically and mentally--of 16, so they have not been big momentum
players on these stocks that have found today's secret of success. For
example, these previously smart investors are still having a little trouble
understanding the action of CMGI moving up 17 points on Friday, because
they only lost $1.08 a share versus the $1.76 expected by the herd of
analysts. As I attempted to lay out my scenario for the coming year, I
heard similar refrains (mostly in private) that they had underperformed the
market miserably since 1996, and moderately even in the two previous years.
Remember, these are real professionals, ladies and gentlemen that manage
billions of dollars, and who have wide acknowledgements of being the
smartest investors in the land.
If you were reading any financial treatise four years ago about investment
styles, you would have been hearing the conclusion that value investing was
the only way to invest for success over the years. The heroes of the
industry were giants such as Warren Buffett, John Neff, John Templeton,
etc. But not any longer. Value investing has now gone to the back corners
of the doghouse. When you have the real leaders being stocks such as
Microsoft that is selling at 77 times earnings, and 28 times revenues,
General Electric at 49 times earnings, Cisco Systems at 120 times earnings,
and Wal-Mart at 56 times earnings it is a little hard for a value investor
to swallow those values. The real champion this year is the NASDAQ
indices, with the NASDAQ 100 up 83% year to date, while it continues to
flaunt its 105 price/earnings ratio in those value investors faces.
These types of crazy market divergences are being broadly chronicled. For
example, another article this weekend brought out that 52% of the stocks in
the S&P 500 were down for the year. It also noted that 67% of the NASDAQ
stocks were down 20% from their 1998 highs, and 45% were down by a huge
40%. But in direct contrast, for a few moments on Friday the Dow Jones
Industrial average traded in all-time record high territory. But even with
that weekending strength, there were 1,116 stocks on the New York Stock
Exchange making new 52-week lows, while only 180 were able to make new
highs. Truly amazing for an old market watcher.
Speaking of age, it used to be that an aging person could joke that they
were so old that they didn't buy green bananas, but with this market
activity the example of seniority is changing. As Friday's volume on the
New York Stock Exchange soared to the highest in history at 1,347,069,000
shares, it now is more impressive to the youngsters to tell them that I am
so old that I remember when the daily volume was 10,000,000 shares.
There are many more examples to describe these air-toys that Mr. Greenspan
's money supply has developed. But as the easy riches has invaded the
headlines, where more and more are tempted to buy their lottery tickets, it
has certainly helped the cash registers to ring out merrily this Christmas
season. Last week the retail sales for November were reported to be up
0.9%--much better than even the optimistic forecasts. The unemployment
insurance claims dropped to the lowest level in 26 years, and industrial
production was humming turning out more balloons for the kiddies.
And then there was the record $25.9 billion monthly trade deficit. With
all this excited consumerism, the US consumer had to step up the pace of
imports to fill the shelves. Imports increased by 1.6% in October. But it
seems despite all those rosy projections of the international economies,
that their consumers are not quite as enamored with our US goods, as US
exports actually decreased by 0.1%. There might be a tidbit of telling
information in that number, as the guilty items to cut the export number
was high tech equipment falling by $1.5 billion. Could this be a slowing
of the trend to become Y2K ready? That might explain why IBM, Hewlett
Packard, Xerox and others have downsized expectations.
But we now only have 11 more days to wait until the real bottom line about
Y2K becomes a reality. No matter what the real story happens to be, look
at what Mr. Greenspan is going to find after he sobers up from the binge
that he has been on for the last 13 weeks. He is going to find money
supply that is flagrantly above the levels that history shows is acceptable
for non-inflationary economies. Looking at the two extremes, maybe Y2K
will be catastrophic. If so, obviously it would create a dramatic economic
shutdown causing huge expenses and dramatic earnings declines. But what if
the more likely scenario is true that Y2K is almost a non-event here in the
US. It will mean that the $50+ billion of excess cash generated by the Fed
to accommodate the wary consumer emergency hoarding, will be ready to be
flushed into an already hot economy. But even if the consumer does what no
one would expect, and that is to put it back into his or her bank accounts,
it would be money that has to be taken back out of the system by the Fed.
Now, what else is the Fed going to find? What about inflation? Last week
the headlines trumpeted the better than expected Consumer Price Index
coming in with only a 0.1% increase. The core rate was up only 0.2%. But
you've got to be kidding. Did you pick up on the fact that the item that
really impacted this "good" number was the 0.6% decline in gas prices in
November? That was not a typo, I said decline. And to really start the
belly laughs, that decline came after they told me that they declined in
October as well, by 0.4%. These obvious mistakes in statistical sampling
will have to be adjusted up in future months, as Mr. Greenspan faces the
New Year.
But even with these obvious mistakes, the US now finds itself in one of
those times when the producer price index is rising faster than the
consumer price index. When you look back over the last two decades, you
find only two other times when this has been the case of similar magnitude.
The first was in the 1978-1982 period, and the second was in the 1989-1990
period. Both periods led to extremely restrictive Fed policy. So happy
New Year to the party host. What kind of "drying out" will the doctor
have to prescribe to sober up all the inebriants? Or will he just keep on
feeding the habit, and blowing up the balloon as he restarted the money
supply pump in that August-October fear attack?
We're not sure why he cranked up the pump again after that mini-panic in
August-October of this year. Watching the put/call ratio, it was obvious
when the dollar was tanking against the yen, when the bond quality spread
widened substantially, and when the long bond yield spiked up, first in
August and then again in mid-October that something was wrong. The story
began to appear that the dollar was in danger of a "melt-down." But rather
than take the bitter tasting medicine, it looks like the Fed just tried to
give the patient one more swig from the bottle to calm its nerves. I guess
it worked. . . . .but only temporarily. The only real cure has be a "cold
turkey" drying out. The only real cure has to be suffering through the
"dry heaves."
The bond market is sure sending that message again as the long bond moves
up to a 2-year high in yields. So as the New Year passes, we believe the
Federal Reserve will have no choice this time. It is time to pull the plug
on the artificial breathing machine. It is time to see if the patient can
make it. We think the market will force the Fed to make that decision.
So when (or if) the Fed acts to bring money supply back into bounds,
history tells us that it will have an effect on this " bull" market. If
you look back for the last two decades, you will see that in every instance
that money supply as measured by the broad MZM aggregate moves above the
10% growth rate on an annual basis, and then is reigned back under that
target level it affects the market significantly. In each instance that
moves above 10% the broad market, as evidenced by the advance decline line,
starts to under perform. The narrow action of the highly liquid stocks
continues to feed on that excess liquidity for a while longer, but when the
juice is removed (back below 10%) the "drying out" begins even for those
high-flyers.
In April of this year the Fed looked as if they were trying to reign in
the runaway money supply, and the annualized rate started declining. True
to form, the broad market hit a real stumbling block since then, but the
highly liquid stocks have been still feeding off the excess. The lapse in
the Fed's new discipline after that October panic really fanned the flames,
but we think the advent of the New Year, and the removal--one way or the
other--of the Y2K threat, will bring back the Fed to the old religion of
the past. Another key determinant will be the make-up of the Fed's voting
Presidents. The relative "easy" Fed Presidents who have been voting this
year will be replaced by at least two ardent "Hawks." Jerry Jordan and Al
Broaddus. I'm not a big fan of either, but in this instance maybe an extra
harsh disciplinarian is what the doctor ordered.
But the day of reckoning is at hand, in my opinion. It should have been
in April of 1998 before the patient got so addicted to the drugs. It will
be harder now, but it is either that or. . . .I don't want to talk about
it. |
