Monday, September 23, 2002 Market WrapUp (Puplava)
Who Wants To Be a Pauper?
At the peak of the bull market, one of the most popular television shows was Who Wants To Be a Millionaire. The show went along with the height of the bull market. Times have changed. We are no longer in a bull market, but have now begun the second phase of a bear market that should produce several “white knuckle” moments. The average investor has been holding on to his mutual funds, believing the mantra "Stocks always go up in the long run." Yes, they do, but those long runs are often punctuated by extended periods of losses when stocks fall precipitously, taking years to recover. This is one of those times. However, even though the stock market has been falling double-digits for three consecutive years, we have yet to see investors capitulate. Instead, the media has done numerous stories about Main Street holding on. For the last year investors having been putting their head in the sand and playing ostrich. They don’t look at their monthly mutual fund statements or their quarterly 401(k) reports. “Why bother? I know it's down,” was the response from one HR executive at a major Midwest manufacturing firm. Perhaps this complacency may lead to a new TV show, Who Wants to Be a Pauper, for that is what is going to happen to the portfolios of those who continue to play ostrich with their accounts.
That snug complacency may be about to change. That complacency will turn into fear and that fear will produce panic. When that occurs we should see what has been missing so far in this bear market, which has been a selling capitulation. When mutual fund redemptions start to make front-page headlines and we have a series of 90% down days in the market, you’ll know we are getting close to the capitulation phase. We have to get there first before we get to any meaningful bear market rally -- and I mean bear market rally only. Bear markets have three phases to them, and we have only gone through the first phase. The second phase is now in the process of unfolding. These one-day, one-week wonders are all we have gotten this year. They have been the product of intervention in the futures markets to cushion the fall. Intervention seldom prevents what it is designed to hold up, and so it shall be with this next phase of the bear market. So far this year $3 trillion in stock market wealth has been wiped out. We now stand at losing an equal amount of wealth in the next phase of the bear market, which should definitely put an end to the ostrich effect on Main Street.
At some point during this next phase of the bear market, it will get bad enough that the Fed will surprise the markets with a rate cut. It did not get the cooperation it needed from the ECB this month, so rates have remained on hold. However, Europe may be forced to act as a wave of deflation, unemployment and slower economic growth sweeps across Europe. The pressure for the ECB to ease is growing as unemployment rises, financial markets collapse, and economies weaken. European equity markets this year have lost as much as the US Nasdaq. Many markets from London to Paris to Bohn have fallen 34% to as much as 46% in Stockholm. If things get bad enough, eventually central banks will act in unison to give the markets a major shot of monetary stimulus; while governments will be writing out unlimited checks on the fiscal side. We’re not there yet, but we should be getting close. Japan is now monetizing its financial system by buying stocks out of bank portfolios. In the U.S. the BCA Financial Stress Index, which measures financial stress in the financial system, is now warning of a financial accident waiting to happen. The shares of JPM failed to close above $20 a share today, which may be a portent of the future. This is a bank that is loaded with derivatives, bad loans, and sinking profitability. This is one to keep your eyes on, for it may end up becoming the next Enron. With a derivative portfolio of $25.9 trillion growing at double-digits a year, there is plenty of room for a major accident to happen. What are the chances that all of those models have programmed and accounted for all the potential rogue waves that are now growing in size and waiting to hit our shores?
Rumblings Around The World
This is the big unknown that the Fed must be monitoring around the clock. Events in Asia, and now in Latin America, accentuate risks here in the US. There is a major crisis unfolding in Japan. The government has had difficulty selling its last batch of bonds. In Latin America, Brazil’s currency and financial markets are falling apart. Brazil’s market, which lost 3.35% today, is down 32% for the year, and down 56% when measured against the dollar. Brazil’s currency has fallen close to 25% this year. What is worrying bankers is the rise of Brazil’s socialist workers candidate, Luiz Inaciao Lula da Silva. Lula is 25 points in the polls over his moderate opponent, Jose Serra. At stake is Brazil’s $330 billion debt. Lula has long advocated defaulting on that debt, mainly owned to western bankers. Financial assets have fallen by a third since Lula’s standing in the polls has been rising. He will most likely be Brazil’s next President and it is almost a given that he will default on the country’s debt. As sign of growing financial stress, Brazil’s government bonds are now yielding close to 24%, a signal that things are going to get worse. It now remains a question of whether bankers can control the fall, or if it simply takes on a life of its own. The questions that should be asked are who all the money is owed to and what impact will a Brazilian default have on the financial institutions that own it.
We have signs of financial stress emerging everywhere, and when there is financial stress, you will find it leads directly to financial institutions, mainly money center banks. What we know from past crises under the reign of Mr. Greenspan is that when they emerge, the standard response will be to lower interest rates and flood the markets with liquidity. Perhaps a Brazilian debt crisis and a stock market crisis, combined with a derivative crisis, should give us the coordinated central bank intervention in the markets that will lead us to our next bear market rally. Mr. Greenspan is running out of bullets, so he had better make his aim sure with what he has left.
Monday Blues
Meanwhile, this morning’s batch of news stories didn’t help stock prices much as stories on the economy, earnings, and geopolitical events sent stocks falling. A sample of some of the news faire point to major adjustments ahead for the financial markets. The Leading Economic indicators fell for the third consecutive month, forecasting a downturn six months out. The Conference Board’s economic forecasting gauge fell 0.2% in August after falling 0.1% in July. Seven out of the 10 indicators fell last month, indicting more trouble lies ahead. Other headlines appearing on the front page were earnings warnings from JDS Uniphase, restatement of revenues for two years of close to $1 billion for Qwest Communications, softer sales from Wal-Mart, Adelphia’s Rigas founders indicted for defrauding the company, and Peregrine filing for bankruptcy. Those were just this morning’s headlines.
By the afternoon there was story about investors in drug companies getting inside tips. There was also this morning’s WSJ story “Storm Warnings Replace Profit Dreams,” which deals with the fact that there will be no miracle profit recovery in the second half of the year. Pro forma earnings estimates have fallen from over 16% in July to around 8.5% as of last week. I’m sure that number will go even lower as this week and next week progresses with even more warnings. Analysts are taking the knife to fourth quarter numbers as well. They have fallen from close to 8% to around 21%. That number will be down dramatically after companies start reporting their actual numbers late next month. Shares of Nucor tumbled after the steel company said third quarter earnings would be weak. Microsoft shares fell after the company CEO, Steve Ballmer, said he doesn’t see any improvement in European demand for its software products. The earnings news in the next few weeks should get worse and worse, as it should be, because the dreams of a second-half recovery were all a myth in the first place. Those rosy pro forma numbers (nobody talks about the bottom line numbers) are going to evaporate into thin air. This is what the market is now starting to price in -- weaker economic growth and lower earnings.
Support Levels May Give Out
With today’s fall in the markets we are now getting close to those July key support numbers for the major indexes. The key number to watch for the S&P 500 is the July lows of 774. The S&P 500 is only 36 points away from its July 23rd lows. The Dow is sitting 170 points above its four-year closing low of 7702.34, reached the same day in July. The Nasdaq tested support at 1200 and broke down. Technically, the market is now breaking down from a recent head and shoulder pattern, which points to trouble ahead.
Perhaps more important for the markets, as household net worth gets wiped out, you may see not only the consumers capitulate on holding on to his mutual funds, but consumer spending may also come to a screeching halt. Consumption expenditures have been mainly in housing and autos. But corporate layoffs are starting to accelerate again, so the lethal combination of job losses and shrinkage in net worth could deal a severe blow to consumer confidence, which will be reported this week. If those indexes fall, it might mean the crucial Christmas retail season directly in front of us could run into problems.
War Stories Ramping Up
Other stories impacting the markets were on the geopolitical side where a series of reports this weekend indicate the US is preparing the battlefield ahead of its war against Iraq. The Washington Post did a story about US war plans that have been submitted by the military to the President. It included chilling detail of locations to be targeted as well as hints of secret new sci-fi weapons, capable of draining energy from Iraq’s electronics and telecommunications systems. The New York Times also has a story talking about moving special forces and marines into position along with the dispatch of possible three carrier battle groups: the Carl Vinson, Constellation, and the Nimitz. The Abraham Lincoln, the first carrier to include 12 F/A 18E Super Hornets in its air wing, is already in position. The F/A-18E is capable of flying longer and carrying more bombs. Logistical tasks such as fuel, water, and food are being stocked up. Before the troops attack, you need to have supplies. Soldiers don’t fight well on empty stomachs and planes and tanks don’t run unless they have fuel. First the supplies, then the soldiers.
Geopolitical concerns, along with declining inventories, sent the price of energy soaring. Heating oil rose $1.87 to $80.57 up 2.4 percent for the day. Oil prices rose $0.87 to $30.71. Once they cross $31, they are on their way to $40 a barrel. Natural gas rose $0.22 to $3.978, up nearly 6 percent. All we need is a disruption of supplies, along with bad weather, to get our next energy crisis. Mexican oil workers are set to go on strike and Venezuela, a key supplier of oil to the US, is experiencing greater social unrest. Government troops have had to use tear gas against oil workers demonstrating at the state run oil companies’ headquarters.
Given all of the uncertainties that the markets will have to contend with and sort out --- the economy, earnings, the war, and terrorism --, it only has one way to travel, which is down. Intervention by authorities may forestall it, but not prevent the markets eventual destination. Today the major indexes came within close proximity to their summer lows. In the case of the NASDAQ, it hit a six-year low with more lows eminent. Deteriorating profits is shattering the third year prediction of a second-half recovery. Negative pronouncements are running at a faster pace this quarter. Volume was heavier than usual which is the case on most down days. Big board volume came in at 1.35 billion; while NASDAQ volume hit 1.46 billion. Market breath was negative by 23-9 on the NYSE and 25-8 on the NASDAQ.
Overseas Markets
European stocks fell on concern the second administration of Germany's Chancellor Gerhard Schroeder will struggle to spur growth and profits in Europe's largest economy. Deutsche Bank AG, Germany's No. 1 bank, and Epcos AG, a Munich-based electronics components maker, dropped. The Dow Jones Stoxx 50 Index shed 3.7% to 2299.65. The index fell to its lowest since June 2, 1997. All eight major European markets were down during today’s trading.
Asian stocks fell after U.S. home and job reports suggested that growth in the region's largest export market may be slowing. Kyocera Corp. and Taiwan Semiconductor Manufacturing Co. led the decline. Japan's Nikkei 225 Stock Average lost 2% to 9481.08.
Treasury Markets
Treasury issues extended gains in afternoon trades as stocks deteriorated. The 10-year Treasury note rallied 28/32 to yield 3.68% while the 30-year government bond rose 1 3/32 to yield 4.68%. Tuesday will see the release of September consumer confidence, which is seen slipping to 92.3 from the previous month's reading of 93.5.
© Copyright Jim Puplava, September 23, 2002 |
