Hang Tight, Be Selective

• January 14, 2002
• Dave Floyd

It finally
happened, the myth of the bold new recovery and the ushering in of a
new era of economic nirvana had the air taken out of it. The messenger? None
other than Alan Greenspan. On a personal note, I have to admit I had a little
bit of a smile on my face when the news came out. I was growing tired of
listening to the “sound-bite” investment analysis, when everything I
was seeing and reading pointed in the opposite direction. The disparity between
sound-bite economics and hard-hitting, objective analysis was truly stunning.
The bursting of financial bubbles creates many problems, most common is the
belief that the worst is over. Many excesses still need to be worked out of the
system before a recovery with a solid base can take hold. Now I am not wishing
for doom and gloom, I am just being realistic. This week will be quite telling.

When one looks at all of the other
scenarios unfolding, it does cause one to consider re-evaluating how they will
play this market going forward.  In today’s piece I will share with you not
only my usual analysis for the day ahead, but also how you may want to focus
your attention in light of Friday’s bombshell.

First off, the landscape going
forward: The bulls are going to need to take a serious look at the levels they
have driven this market to and consequently the valuations. They relied on the
same economists who missed calling the recession in March 2001 to tell them that
the end of this “pesky” roadblock was just a mere month or so away.
Whoops!

On the bright side, the short-term
trend is still up, and it is certainly possible for the economic recovery to
take hold in the late spring.

The bears however, have few more
things to be confident about, for their case to play out. Valuations (if the
market ever decides to recognize them again) are way ahead of themselves,
especially after Greenspan’s comments today.

Layoffs continue at a torrid pace,
although at different times in economic history the unemployment rate has
continued to deteriorate while the economy has been officially out of a
recession. The jury is still out as to whether or not that is the case this
time.

Most importantly is the growing
fallout from the debacle of Enron
(
ENE |
Quote |
Chart |
News |
PowerRating).
On Thursday we had the accounting firm which represented Enron, Arthur
Anderson, say that they may have destroyed documents pertaining to
their client. Excuse me? You did what? If this does not raise some red flags,
what will? The resulting fall-out could be very interesting, especially as we
head into earnings pre-announcement in the next couple of weeks. How many other
companies are out there that have used, let’s say, creative accounting
techniques in the interest of stock price over the last few years?

The ramifications (and this pure
speculation, but again, knowing possible outcomes alerts you to opportunities
when they present themselves) are dire. Will accountants and corporate
controllers be as willing to push the limits of GAAP (Generally Accepted
Accounting Principles)?  If so, what does that do for earnings going
forward? You can bet they would need to be adjusted downward. Or worse yet, what
if you had to re-state your earnings for the last year or two? Do the names Mercury
Financial, Informix and Purchase Pro
jog your memory? Just something to think about.

The following quote from Bill
Fleckenstein highlights the tug of war which exists on this whole issue of
corporate accounting:

“It will also be most
illuminating to see what Art Levitt has to say when he testifies in front of
these hearings. People may recall that when he was head of the SEC, his efforts
to reform auditor independence rules were roundly opposed by the present
chairman, Harvey Pitt, who at that time represented the Big Five and their
accounting association. So, we potentially have a situation with the current and
former SEC chairmen on opposite sides of an issue. We await further developments
with keen interest.”

If in fact the economy is not out of
the woods yet, and as layoffs mount, while consumer debt reaches nosebleed
levels, one has to wonder how those consumer finance stocks will do. Even prior
to Sept. 11, I was a bit suspect of these stocks, but at this juncture the
timing may be a bit better and a few look particularly noteworthy on the short
side.  

The real kicker would be if payment
delinquencies increased and some of the aggressive accounting (purely hearsay,
no hard evidence to back this up) that these firms have used is deemed
inappropriate. We will just have to see.

Looking ahead to
today’s session, I hope to see a little more volatility come into the market.
Yes there was the big spike down on Friday, but after that the action was really
pretty subdued. If there is not a noticeable up tick in volatility soon, I will
go back to trading off of 5-minue bars.  I have to say, I have never seen a
market get off to such a shaky start (from an intraday trading perspective)
since getting started back in 1994.  Additionally, many other traders I
speak with are also echoing the same. One thing is for sure, there will be a
catalyst which will re-ignite volatility and I feel that we are very close to
that point. So hang tight, and be selective.

Key
Technical Numbers

As always, feel free to send me your
comments and questions.  See you in TradersWire.

Dave