Underground Man 2001

• May 5, 2001
• Goran Yordanoff

“After all, man is stupid, phenomenally stupid. Or rather he is not stupid at all, but he is so ungrateful that you could not find another like him in all creation. After all, it would not surprise me in the least, if, for instance, suddenly for no reason at all, general rationalism in the midst of the future, a gentleman with an ignoble, or rather with a reactionary and ironical, countenance were to arise and, putting his arms akimbo, say to us all: ‘What do you think, gentlemen, hadn’t we better kick over all that rationalism at one blow, scatter it to the winds, just to send these logarithms to the devil, and to let us live once more according to our own foolish will!”‘

— From Underground Man by Fyodor Dostoyevsky 

Thank goodness the
“bad ‘ole days” of early April are behind us and we can now look forward. After all, looking to the past certainly does not serve us well as market technicians and historians when we are under the rule of Augustus Allanus Greenspanus. Wednesday morning’s American Association of Individual Investors survey revealed that as of this week, 63.5% of those surveyed were bullish while 21.62% were
bearish — a bit extreme at both ends. However, looking to the past, a bullish level above 60% has usually marked a market top (within a week or so) at five different times in the past two
years — but who the heck cares about history, anyway? 

You know that old guy Buffet? Yeah, the guy who has doubled the return of the S&P 500 for the past 25 years. Anyway, that guy had a few things to say about the market this week as well: “Lots of money was transferred from the gullible to the promoters.” He also added that Wall Street benefited, “not by great performance, but by great promotion.” Promotion, indeed, and the promotion continues to rage on and astound. But who cares what Buffet said, his returns doubled the S&P 500 index for the past 25 years, we’re only interested in the
future — he’s a relic of the past.

I am constantly being asked, “What are you buying right now? You’re not? Why the hell aren’t you buying?” I try to respond by stating that, historically, the market always creates a time to buy. These times are characterized by valuations below historical averages and dividend yields at levels that create good “investments” (if we can even define what that word means
anymore). At present, an S&P 500 with a valuation of at least 25 time price/earnings, trading at 6-7 times book value, and with a dividend yield of 1.2 % hardly constitutes such a time to be buying. 

Yet the speculators who lost a good portion of their money in 2000 now believe the excesses of a decade have been run off and we are ready to rally back up in the same manner we did in late ’99 and early ’00. There is a sense of desperation that the last stagecoach out of Dodge has left and they are running after it, desperately trying to grab a hold. After all, they used this same method before so why the heck shouldn’t it work again? Their losses occurred in the
past — forget about the past, the market is different this time. 

So, how are we to warn investors who are enamored with the newfound love for the camera that countless
CEOs are exhibiting? The unabashed posturing by various CEOs for hungry analysts who are desperate to reveal any shred of newfound “visibility” that wasn’t detectable a week ago has just whipped everyone into more of a frenzy. It is clear that the 21st century CEO is no longer managing their firm, but rather, is managing their firm’s stock price. We heard it best from the CEO of
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So what can we learn from the past? For starters, the realm of human emotion has changed little over the centuries. William Fleckenstein spoke at the Grant’s Interest Rate Observer Conference last week and cited a column entitled
“The Trader” in Barron’s from March 24, 1930, since, as Fleck says, there existed an attempt to prove that the worst was over and “that happened in the early part of 1930 when the mood was not so different from today.” 

“The Trader” column from
Barron’s March 24, 1930 issue stated: “…the public preference for stock is not only as marked as ever, but also the will to speculate is still a speculative factor not to be overlooked. The prompt return of huge speculation and the liberal manner in which current earnings are again being discounted indicate that it will be difficult to quench the fires of stock market enthusiasm for long.” 

Fleck goes on to mention that this article was written about three weeks before the peak of the famous
“sucker’s rally” after which the market dropped 90% in the following two years. Not to exclude our friends in Japan, the Nikkei also recorded an impressive 38% rally up to the 27,000 level over a
six month period following a 50% decline from 39,000 to 19,800 over the course of
nine months. But here I go again, talking about the past. I need to forget that the past is relevant in any way whatsoever and just focus on what the promises are for the future (as presented by the market promoters Buffet mentioned last week). 

Yet, by following the market’s progress over the past month one might conclude that the U.S. has enjoyed a sudden breakout of prosperity. But the sad reality is, nothing can be further from the
truth. What, if anything can we learn from the past this weekend?

What were the most important things we learned about the markets and the economy this week. Let’s highlight the most striking events:

1) The April non-mfg NAPM index fell to 47.1% in April–a record low for this indicator. This sub-50% reading in the April service index now joins the nine months of sub-50% levels in the manufacturing index. Clearly, this indicates that the service sector which was touted as being the economy’s Messiah just a week or so ago has now slipped over the edge of contraction.

2) Fed Beige Book. The Fed essentially stated that the economy remained sluggish, although they do not suggest that the economy has entered a recession (since, in a technical sense, there would need o be two consecutive quarters of negative growth). They reported mixed signals regarding business inventories, labor markets, high tech and telecom related sales, and new vehicle demand. It appears, however, that the Fed is focusing on consumer demand for homes and cars which, while weaker, is still healthy. In addition, they also acknowledge the reality that energy prices will continue to rise through the summer months and that businesses are set to pass these costs unto consumers. 

3) April employment data saw the weakest payrolls report in a decade. The unemployment rate rose to 4.5% from 4.3% and non-farm payrolls shrunk by 223,000 jobs. This report suddenly confirmed Tuesday’s NAPM number in casting a dark cloud over the recovery scenario. As such, the fed funds futures immediately priced in the virtual certainty of a 50 bps cut at the May 15 FOMC meeting.

What do all of these things have in common? Well…they all created buying opportunities, silly. The market’s sense of reality is now focused on the “job cuts equals rate cuts” relationship. Nothing else even remotely matters. Until the rate cut parade has expended itself and future economic data reveals that monetary easing isn’t the cure-all that some had touted it to be, the market seems to have nothing but blue skies ahead. Rest assured, that by the time this realization sets in and the market creates another wall of worry (which no longer exists at the present time) Wall Street will have succeeded in yet another chapter of Buffet’s “transferring of money from the gullible to the promoters.” That’s just the way this Great Game works. 

At the rate the Federal Reserve is cutting interest rates, we only need another 6 months before the U.S. rate equals that of Japan’s: zero. In the meantime, the printing presses are running overtime as Alan Hood and his gang of merry governors continue to roll out the red carpet of rescue liquidity. Let there be no doubt, this stock market rally was brought about by the Federal Reserve intentionally and specifically for the purpose of boosting equity prices through the unprecedented explosion in the money supply. 

After all, if you would have just listened to the analysts and bought their recommendation on Friday, you could have bought RF Micro Devices
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PowerRating) at the open for $28 and sold at $32.60 at the close for a whopping 18% return in 6 1/2 hours. Not bad for an upgrade to “buy” from “long-term buy” after the stock has already appreciated by 350% over the past month. In fact, I believe we are seeing a pattern once again that signals the fact that market has once again become detached from reality. Let’s look at some charts:

This chart is not a short recommendation. It is an example of how brokerage firms feed on greed and stupidity. Would you buy this stock after it has run over 350% in
three weeks because some obscure person at a brokerage firm upgrades it? True lunacy but a clear example of the speculation and complete risk aversion fueling the current market run.

The video game hype is reaching mania levels as gaming stocks such as
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PowerRating) continue to defy reason and gravity. Apparently, we are being told that the new Microsoft X-box will take over the world. Strangely, I remember how everyone had to have an Atari 2600, 5200, Colecovision, SEGA Dreamcast, etc. at the time as well. Could this be another setup taking place in which the market is creating “bag holders” that will left holding stock after insiders and major shareholders have sold into the hype? Time will tell. Fascinatingly, Credit Suisse First Boston upgraded THQI this week after it has had a 500% run in the past year. Magnificent timing, CSFB, you are a credit to the bubble and the speculators that comprise it.

Time to buy CECO? Is it really that great of a value? Wall Street once again thinks you should be buying this stock here because an obscure analyst form First Analysis Securities says you should. After a 500% move, this may not represent a prudent investment. Remember, you don’t have to have any credibility, justification, or integrity to move a stock—you just need to arbitrarily announce a price target and the lemmings will come for it.

Finally, a chart of the NDX 100 index reveals that although the Dow Industrial Average has exceeded its April highs after the surprise rate cut, the NDX cash is not confirming those highs. In fact, virtually every rally of the past 8 months has failed when the NDX has failed to confirm new highs being made by the Dow (remember, the NDX cash presents a better representation that the Composite). 

At present, the gap down from Thursday morning’s open looms above as resistance. The Tuesday through Thursday chart pattern also formed a picture perfect evening star formation which has bearish implications. Will the bearish scenario finally come to fruition based on past performance when the indexes diverge? Will the evening star even matter? Truly, Tuesday’s high in the NDX cash and Nasdaq futures hold the key as neither got close on Friday. With the Dow looking like it is going to blast through 11,000, we are not getting confirmation from either the utility index ($UTIL) or the transportation index ($TRAN). 

Friday’s trading looked very labored once again as tick readings near the end of the session were suspended for extended periods of time above the +900 levels. There is something huge pushing the market up and there is no telling when it is going to stop. My personal feelings are that the Federal Reserve, come hell or high water, is determined to push the Dow up to new highs to produce a sense of euphoria throughout the country.

For next week, be cautious as the market continues to convince the masses that “the only risk to the stock market is not being in it.” (as our friend from A.G Edwards so confidently proclaimed this week)

There are a lot of economic numbers coming out next week ranging from consumer credit, retail sales, productivity and labor costs, capping off with PPI on Friday. This should be a wild and wooly one. A failure of the NDX cash and futures to confirm the highs in the Dow will create some magnificent short-term shorting opportunities, but this is a big “IF”. The current market is a runaway freight train that should not be taken lightly. We are in the midst of the fiercest bear market rally since 1930 and should consider preservation of capital as our paramount concern. There will be a time to play, oh boy will there be a time to play. In the meantime, going long this market outside of intraday scalps or short term trades is not worth the risk. 

Have a great weekend.

Goran