The House of Cards That Morgan Built...
Despite the volatility, the broader stock market managed to close higher last week. The S&P 500 finished the week up a little over 5 points after having posted a new 5-year low last Wednesday. The Dow was up over 245 points. But the Nasdaq fell another 57 points. Meanwhile, gold got clobbered, falling to just above the psychologically important $300/oz level. And the dollar manage to stabilize and post a gain for the week.
The big news was last Wednesday’s major reversal in the stock market. We have yet to see any significant upside follow-through on that reversal, but so far the bottom looks real. Real short-term, that is. Not to say that stocks can’t rally a hell of a bunch from here, but it’s not likely that the bear ended for good early Wednesday morning.
I sent out an email to Mid-Issue Update subscribers on Wednesday morning suggesting that we were likely looking at an important short-term bottom. I didn’t hear it mentioned in the financial news, but what caught my eye first was the market’s hesitancy when approaching the level that is exactly 50% of the S&P 500’s value at its bull market peak. In fact, the decline stopped less than one point below that exact level. Surely that had to mean something.
And indeed it did as the rally in the following hours clearly demonstrated. We were dealing with a market that hadn’t seen the light of day in weeks. Buying the 50% level of the market’s all-time high value was as good an excuse as any.
Was it "the" bottom? Not likely. A plunging stock market has created more problems that it has resolved. While lower prices have served to wash some excess out of the post-bubble market, they’ve also served to wash away a lot of the fat that had grown over the truth. As if all those accounting scandals weren’t enough, now we’re learning that JP Morgan is leveraged to the hilt and was apparently instrumental, along with Citibank, in helping Enron pull off the "fraud of the century". Of course, officials at JPM are denying it.
WHAT ELSE ARE THEY GONNA’ DO? Jump up on a table-top and bop to the "happy happy joy joy we’re in partnership with criminals" dance of eternal prosperity? I don’t think so. It’s their job to protect their interests. And try to stay out of jail. When you’re guilty, lying is your only shot. I’m not saying they’re lying. How would I know?
But if they’re not lying, they sure are bloody stupid. Craig Harris, president of Harris Capital Management (www.harriscapitalmanagement.com) turned me on to the whole "JP Morgan derivatives mess" thing. Seems that the old House of Morgan is leveraged out to the tune of about $24 trillion dollars. That’s 2.5 times our nation’s economic output. Said another way, that’s a lot of money.
Adam Hamilton at Zeal Intelligence estimates that for every dollar JPM has in equity, there is about $618 of exposure in the derivatives house of cards. You know what it takes to wipe you out with that kind of leverage? A 0.16% move against your position. That’s right. The market moves less than 0.2% against you and all, 100% of your equity is gone. How likely is a 0.16% move in any direction? Pretty much a guarantee. Heck, my account fluctuates by more than 0.16% every day, if not every hour.
You know what happens when the position goes 5% against you? You go down and a whole lot of your investors, companies you deal with, go down with you. And when you’re a company that has dealings with nearly every company in the Fortune 100, if you go down, the repercussions are felt throughout the entire financial system. Can you say "derivatives crisis"? If not, start practicing now because you might be saying it a lot in the future.
There’s a new rumor circulating now: that JP Morgan collapsed last year and has been taken over and run by the Fed ever since. I don’t know, though. They don’t tell me these things. I stopped getting phone calls from the Fed a long time ago. So long ago that I don’t even remember having gotten any at all.
You see, here’s the public and the media out looking for a market bottom and operating under the delusion that a "bottom" is some fixed absolute figure that only needs to be discovered. In fact the bottom is just a concept that gets pushed farther and farther away as every emerging crisis comes to the surface. Stocks fall further and more truths come out, more bottom lines collapse and more people get hurt. They get hurt and they sell more stocks. And voila! The bottom becomes that much more elusive.
We will hit the bottom eventually, but it’s hard to believe that it happened last week. I’m pretty sure last week marked an important short-term bottom and that a major sucker’s rally is in the works. Some follow-through on last week’s gains would serve to solidify that notion for me.
But the market won’t bottom until there is perceived value. An S&P 500 p/e of 35 isn’t perceived as value except perhaps by the jackasses on CNBC who don’t need to understand value. They get paid for keeping their teeth clean and speaking in mono-syllabular words so that the public understands clearly that they "must buy this stock now cuz it’s goin’ to the moon, Alice!"
There isn’t value in this market. Despite the declines, it still isn’t cheap. S&P 500 earnings have fallen by their greatest percentage since the 1930s. And that’s played hell with the "e" portion of the "p/e".
Listen: it takes buying to end the bear and start a bull. Tell me how much big, smart money is out there looking at the S&P 500 and drooling, thinking "golly gee! 35 times earnings! Now that’s value! I’m gonna’ buy this sucker now before the p/e gets to 70!"
Two trillion dollars have been erased this month. You want to push the market back to where it was trading last month? It’s likely going to take a couple trillion to pull that off. Where is two trillion going to come from? Corporate profits? From the decimated, obliterated and overwhelmingly frustrated 401k plans?
It takes money to make a bull market. Let’s not forget that. People think the market is some mystical entity that simply rises in anticipation of good times ahead. But it’s not. It’s the collective result of millions of perceptions, beliefs and ideas. It’s the result of money being put behind those ideas. If there’s no perception of value, no perception of future gains and no money, there’s no bull market. And that’s why there isn’t going to be a bull market anytime soon.
I’ll go on record as saying that if we get some follow-through this week, we’re likely to see a doozy of a sucker’s rally. I don’t know how far it’ll carry but maybe to the 950-1000 range. Maybe more. And yet I’m not willing to put much money behind that viewpoint because there is still a mess brewing under the surface, waiting to explode. The market could just as easily bust through to new lows as it could stage a sharp rally.
You’ve got the derivatives mess which is very real and very big, a disaster waiting to happen. And you’ve got South American economies crumbling as we speak. Believe me, lots of U.S. banks and brokerages are exposed to South America. Eventually THE bottom will come. But it won’t come until there is value in this market. And there is no value in massive structural weaknesses, ridiculously leveraged derivatives positions waiting to unwind and a severe lack of trust in corporate data.
The U.S. stock market is NOT a bargain! It’s NOT a value! The perceived RISK is currently MUCH higher than it was when this market was priced 100% higher. Folks are more suspicious of this market’s value now than they were when it was trading at 1550. How much committed buying do you think we’re going to see in the midst of Enron, Worldcom, Citibank, JP Morgan, Argentina, Brazil, Uruguay and Venezuela?
Oh there will likely be buying, but not the kind that makes bull markets. Just the kind that characterizes a bear...The kind that has everybody excited about the bottom, excited about the new bull market, the kind that fishes in enough suckers to start the process of declines all over again...
Mark M. Rostenko
editor@sovereignstrategist.com
Copyright 2002 by Mark M. Rostenko and The Sovereign Strategist
sovereignstrategist.com
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