Of Greater And Lesser Fools
Market
Trend: Up but topping pattern evident
Market Outlook:
Cloudy with a chance of correction
Sector Watch:
Tech (-)
David’s Pick:
Short the Cubes, Long Emerging Markets
Peter’s Pick:
Penny Ante Stuff, VWPT, SCKT, WGRD
Broad Market Outlook:
“This is not just a bear market rally but the biggest
sucker rally in history.†— Jeremy Grantham in Barron’s,
Nov. 3, 2003
In
the corporate-finance textbooks,
they teach you that a stock price is nothing more than an expectation of a future
stream of earnings. So defined, the only relevant metric for forecasting the
stock market should be the level of corporate earnings, which is, of course,
determined by the strength or weakness of the economy.
It follows from this definition
that it also should really be totally irrelevant that there is a lot of cash
sitting on the sidelines waiting to enter the market. Indeed, from this definition,
any cash sitting on the sidelines should STAY there
IF stock prices have become overvalued.
Clearly, stock prices HAVE
become overvalued but still the money pours in. Why? This is where another part
of corporate-finance theory comes in.
To wit, the return on any
given stock is not just from the dividends one might receive that flow through
from legitimate earnings. It is also the capital gains one might get from the
appreciation of the stock price. Thus, if investors are willing to bid up the
prices of stocks FAR ABOVE THE LEVELS WARRANTED BY PROJECTED
EARNINGS, other investors will continue to flood into the market, in
order to benefit from the stock-price appreciation and capital gains that result
from the process.
Of course, this kind
of momentum-buying was precisely the force that drove the great tech bubble
right up until March of 2000. It is a process that, at some point, becomes largely
divorced from market fundamentals. Indeed, once it reaches a certain point where
stocks are overvalued, it becomes a purely technical phenomenon based on price-and-volume
action.
At the heart of this momentum-buying matter is a third important piece of theory
— that of the “greater fool.†To wit: As long as there are
investors willing to continue to bring money into the market and drive prices
up, you’d be a fool NOT to keep putting your own money in. Just don’t
be that fool caught holding the bag!
Of course, once the “lesser
fools†do start withdrawing money from the market and booking profits,
the market must collapse back at least to the point where prices are justified
by earnings — and maybe, in the rush for the exits, prices may even plunge
lower.
So the question as to how
long this rally will continue must be answered by your belief as to how many
more fools there are left to enter the market and just how far above stock prices
have gotten beyond reasonable, fundamental-based valuations. Our view is that
for months now, stock prices have been overvalued. Like Waiting For Godot,
we have waited for a market correction. We have frankly underestimated the great
reservoir of fools out there eager to push prices up at almost break-neck speed.
Push, at some point, must come to shove. In the meantime, you can either choose
to be a fool or cautious — as we are. If you go the fool route, just be sure
that you are a lesser fool and have an escape plan.
The Week’s
Macro Data Market Movers:
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We still appear to be in
the economic sweet spot, so key reports like the ISM, service ISM, and factory
orders should offer no downside surprises. The smart money will, however, keep
its eye on any signs of lagging productivity, which would raise concerns about
inflation and Fed rate hikes. The politicians will also closely watch for some
signs that unemployment is abating. That said, look for the market to struggle
more on the technical than the fundamental side.
Peter’s
Picks: Penny Ante Stuff
Watchguard
(
WGRD |
Quote |
Chart |
News |
PowerRating) is
an Internet security provider — an area of tech more immune to the business
cycle than, say, computers themselves. It occupies a nice little niche of the
market that goes beyond the standard firewall stuff. Socket
(
SCKT |
Quote |
Chart |
News |
PowerRating) sells
products that connect hand-held and notebook computers to all sorts of “stuffâ€
through both wireless and cable networks. Viewpoint
(
VWPT |
Quote |
Chart |
News |
PowerRating) provides interactive
media and digital content technologies for Internet marketing, online advertising
and embedded applications. It’s already made a nice little move. All
three stocks are HIGH, HIGH risk. All three are showing excellent technical
characteristics. Caveat emptor.
If you have a favorite macroplay or stock you would like
us to consider in this column, send an e-mail to peter@peternavarro.com or go
directly to https://www.peternavarro.com. We’d love to hear from you.