Fed's Poole Yells 'Fire'
By Bill Fleckenstein
03/10/2003 17:21
The foreign markets were a mess overnight, and as we prepared for what looked to be a 1% down opening here, Europe was down 2% to 3%. The market spent about 15 minutes trying to stabilize but was then immediately smacked. Once again, nontech was leading the slide, and tech was trying to hold in there, at least initially. But with the undertow too severe, it wasn't long before most of tech joined the party to the downside. Part of the extra angst was a function of pressure on Fannie Mae FNM and Freddie Mac FRE (more about that below).
Squirreling-Nuts Opportunity Fund: It has been rather amazing to watch tech be so grudging on the downside, even as cheaper stocks such as defense and housing "come in" easily. My explanation for this discrepancy is the ongoing liquidation of equities in general, both by U.S. citizens and foreigners, while the remaining "professionals" load up on octane for the upside move they expect. That's my best assessment of why many big-cap tech stocks are so much more expensive than other securities, and yet so seemingly impervious to the selling all around them.
In any case, what began as a sea of red, one mile wide and an inch deep, became a sea of red, one mile wide and two inches deep, over the course of the day. There's not much point in reprising the action, other than to say today was very, very ugly. Financials were truly clubbed, with the bank stock index down almost 4%. Hardly a stock was green, witness the fact that 94% of today's volume on the New York Stock Exchange , plus or minus, was on the downside, albeit today's volume was light. For those who aren't aware, days when over 90% of the volume is on the downside are regarded as panic days, though normally, one would expect to see them on bigger volume. Today was in essence a quiet rout, with what little relative strength could be found basically confined to certain chip stocks.
Away from stocks, fixed income was higher, and the dollar was lower again. Gold was up $4 and silver was flat, but gold stocks were hit again. Newmont Mining NEM is now down nearly 20% this year, while gold is still up on the year. I think a great opportunity in gold stocks will be upon us pretty soon.
Liquored Up on Leverage: In the damage-du-jour department, credit is due to some worthwhile comments made by William Poole, president of the St. Louis Federal Reserve Bank. (Interested readers can find them at www.stls.frb.org .) Before reprising what I believe is the paragraph that probably got people upset, let me just mention a couple of his statistics: Housing-oriented debt, which comprised only 5% of nonfinancial debt at the end of World War II and about 20% in the early '60s, has grown to 30% today. Of that debt, 40% is issued by Fannie Mae, Freddie Mac or Ginnie Mae. (The latter, as a government-backed institution, obviously has no credit risk, but the same is not true for Fannie and Freddie.) In addition, Fannie and Freddie are far more leveraged than FDIC-insured commercial banks.
Index Close Change
Dow 7568.18 -171.85
S&P 500 807.48 -21.41
Nasdaq Composite 1278.37 -26.92
Nasdaq 100 964.29 -22.23
Russell 2000 348.01 -6.17
Semiconductor Index (SOX) 279.08 -6.81
Bank Index 686.78 -23.15
Amex Gold Bugs Index 119.53 -6.01
Dow Transports 1982.56 -59.92
Dow Utilities 196.26 -4.40
NYSE advance-decline -1,658 -2,001
Nikkei 225 8042.26 -101.86
10-year Treasury Bond 3.57% -0.046
With that as a warm-up, here is what Mr. Poole warned: "The issue with Fannie Mae and Freddie Mac is not primarily one of disclosure. Their annual reports disclose quite well the high degree of complexity of their operations, and the small amount of capital they carry above what is required by law the emphasis is mine . My questions are these: Given the complexity of their operations, is the capital standard in the law adequate? Why is the standard so far below that required of federally regulated banks? What will happen to the housing market if Fannie and Freddie become unstable?" He goes on to supply this disturbing answer: "Should either firm be rocked by a mistake or by an unforecastable shock, in the absence of robust contingency arrangements, the result could be a crisis in U.S. financial markets that would inflict considerable damage on the housing industry and the U.S. economy."
Lack of Contrition, Public Admonition: So there you are. I would just like to pose what I believe to be the operative question: Why did Mr. Poole choose to make this speech now? Why yell "fire" at a time when the markets are smoldering? Why not express all of those concerns in private? I don't know the answer, but I do have a theory. Perhaps Fannie and Freddie -- which have always been skilled advocates for protecting their turf and their favored status as government-sponsored entities -- wanted no part of Mr. Poole's prudence, so Mr. Poole hoped to effect a change of heart by sounding a very public alarm.
Indeed, his comments today sent shivers down the spines of folks already rattled by Warren Buffett's warning that the derivatives market is a "time bomb." (Presumably, this group does not include Mr. Poole's colleague, the ever-unflappable Easy Al, who still regards derivatives as the best innovation since indoor plumbing.) I believe they were as much a catalyst for pressure in the early part of the day as were our geopolitical problems, our weakness in the currency and the melting foreign markets.
Stronghold-Dollar Policy: Now on to another matter of business: I am often asked why I don't recommend stocks for people to buy. Well, first of all, I don't happen to find anything worth recommending. But I am not looking very hard, because I believe that generically, markets are still way too expensive, and it's easier for me to find shorts. That said, if I came upon something I thought was a good idea on the long side, I would mention this in my column. Meantime, the "long idea" I would like to promulgate is the importance of holding cash throughout the bear market, so that when unbelievable opportunities present themselves, and they will, you can take advantage of them. That won't be possible if you keep diverting your cash unwisely.
Along that score, I would like to share some illuminating comments by Justin Mamis. In his morning piece today, he was talking about Kate Welling's interview with Peter Bernstein, which I reprised here last week , though he found more to rant about than I did: "Remarkably, in Kate's entire interview, and we presume in the entire speech which led to the interview, there is not one word of the low-risk alternative . The dirty word is not 'timing.' The four-letter word is of course cash . The virtue of cash is that it takes no risk at a time when the market is in such a state of flux."
Justin continues: "It returns little or nothing, or so it seems, but holding cash has nothing to do with now, except as an avoidance of now . Cash is so as to be able to make fortunes in the long run -- the very antithesis of ad hoc -- by being available at the end of the bear cycle. What could be long term, unto the third generation, more profitable than having -- just sitting there, waiting for the opportunity -- the cash to buy foreclosed estates, tax liens, bankrupt business properties, and ssh , very depressed, very undervalued, very low-multiple 'common stocks.'" And that's the reason cash ain't trash. |
