MARKET OBSERVATIONS

WHAT'S IT LIKE AT THE TOP?

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MARKET OBSERVATIONS - 2/8

Into Thin Air...For the many who make the journey to Everest each year, only a few get to successfully experience the top.  After maneuvering past major roadblocks like the Khumbu icefall and the Lhotse Face, many are simply stopped at camp four as a result of either bad luck (uncooperative weather) or human frailty.  Some succumb to cerebral edema despite trying to condition themselves to the altitude and sheer lack of oxygen.  Likewise, a few brave/unlucky souls are resting for eternity within 500 feet of the summit itself as either ego, bravado, or sheer miscalculation predetermined their ultimate fate.  For those who have made the incredibly arduous trek and have missed their own chances to summit (perhaps for a lifetime), the question of "what's it like at the top?" must forever burn in their hearts.  No book, movie or personal recantation can substitute for the reality in the heart of the true believer/climber.

In the book "Into Thin Air", John Krakauer describes the ill-fated journey of a number of professional climbing teams led by veterans Rob Hall and Scott Fischer.  Both Hall and Fischer died on the mountain while trying to get their "clients" either up to or down from the top.  Does ego enter into the picture?  Sure it does.  Notoriety plays a role.  Lady luck, as always, plays her hand accordingly.  But one of the major culprits for the deaths in this instance is that there were simply too many climbers simultaneously trying to summit that day that led to significantly decreased odds of success for the many.  About 200 vertical feet below the actual Everest summit lies a vertically steep notch in the mountain called the Hillary Step.  It is probably the most technically demanding and challenging of climbing spots on the entire route up Everest.  The key in the Hillary Step's influence over climbers and their success is that it represents a major bottleneck.  Climbers must "wait their turn" to ascend or descend.  One by one.  Ultimate success on Everest is funneled through a needle's eye.  Unfortunately for Hall and Fischer, when too many try to funnel through the eye of a needle at one time, the results can be disastrous.  

We're using our little analogy here to point up two concepts we believe are important in today's market environment.  "What's it like at the top?" is the question of the moment.  The second "eye of the needle"/Hillary Step analogy can be likened to investors being fully loaded in the tech and Internet names.  There's a huge crowd at the summit.  Can everyone descend successfully as storm clouds approach?  The Hillary Step dictates that only those who leave well ahead of the crowd have the chance to avoid the bottleneck.  

What's It Like At The Top?...The "it's different this time" chant is not totally without merit.  It's always different...to a point.  Historians can look back at prior tops such as 1929 and 1973 and attempt to draw conclusions, but until the current bull story plays out fully, the final conclusion can only be a speculation.  As always, our approach is to attempt to draw conclusions regarding relative investment risk and translate those thoughts into investment action.  To call a final number for a top in the Dow, the S&P or the NASDAQ is like trying to pick the winning number on a roulette wheel with certainty.

We happen to be in the midst of a few anniversaries at the moment.  As we mentioned last week, it's economic cycle longevity party month.  February marks the 107th consecutive month of expansion during this new "new era".  The last few months also mark the 10 year anniversary of the secular top in the Japanese market.  It's funny, but in January of 1990 the Nikkei dropped 4.5% as the initial volley in what became (at least) a ten year bear market.  The S&P just dropped 5% this January.  Ten short years ago, the Japanese and their manufacturing technology/prowess were the envy of the planet.  What could possibly interrupt Japanese technological dominance?  It simply could not be seen.  Today we have much the same scenario here in the U.S.  What's it like at the top?  Well, let's have a quick look at what economic and financial characteristics were present in Japan at the time.  Of course we can't help but compare the numbers to where we stand now.  Here goes:

      *  As you know, other measures such as M3 have been much higher.                

      (To be fair, some US numbers were calculated as of year end, while others such as interest rates are recent.)

What does all of this mean?  Probably not much to the opening of trading tomorrow, but it is a view from the top by those who have been there.  While many new age players can only dream of the top, Japan can tell us exactly what it was like "up there".  As you know, many, many Japanese investors were stuck in the bottleneck of the Hillary Step on the way down.  Pushing and shoving to get a place in line so as not to be caught on the summit as darkness approached.  

Remarkably, 1929 in the US was quite similar in characteristics to Japan ten years ago and the US situation today.  Inflation was low.  Economic growth was spectacular.  Unemployment low.  Interest rates low.  Corporate earnings good.  And most of all, the mountain was full of climbers.  Chock full.  Of course we hear it said that today is nothing like 1929.  Today we have lightweight, portable oxygen canisters (a liquidity proficient Fed).  We have dissimilarities such as technologically sophisticated climbing gear (leveraged derivatives), expert guides who know the mountain like the back of their hand, ready to catch us if we fall (Greenspan), and state of the art telecommunications and GPS devices (online day trading).  It's true that a lot is different relative to both 1929 and Japan of 10 years ago.  

Just maybe, the most important point being sorely overlooked by investors of today is that the characteristics of the mountain remain the same.          

The Hillary Step...The bottleneck on Everest responsible for more than a few deaths is well known.  The Tibetan and Nepali authorities grant only so many permits to climbers for Everest expeditions.  What the authorities cannot control is the "collective decision" to advance on the summit in a herd at any point in time.  (Permits are granted for the season.)  Teams can try to coordinate among themselves, but one is dealing with teams from many different countries and cultures.  Weather conditions largely dictate climbing decisions.  Fair weather is the signal to attempt the summit both individually and collectively.  A mass of climbers forced to take their turns at  the Hillary Step on the way down the mountain is an analogy for today's investors in the Tech and Net stocks.

As we have described to you in many ways over the past few months in our discussions, a mass of investors have already funneled onto the Tech and Net summit.  The mo players, the day traders, the sector rotators, the mutual fund crowd, etc.  We've described to you the indices top heavy with Tech and Net.  The high altitude storm clouds are off in the distance while these investors are high-fiving each other for having summited.  They are planting flags at the peak.  They're taking pictures, both physical, emotional and psychological, of their incredible victory.  At the summit, blue skies and sunshine fill the scenery.  1000 feet below, wisps of clouds have started to form.  A few flakes of snow are falling, melting before they hit the mountainside.  A small number of climbers have already started down the mountain and are slowly taking their respective turns descending the Step, one by one, cognizant of the forming cloud mass below.  For a very large number of today's Tech/Net investors, the Hillary Step awaits.  They don't seem to realize that the bottleneck has already started.

Some time ago we penned a piece called "The Other Side of Stock Split Madness".  We argued that "on the way down", it's not massive selling that accelerates the decline, it's simply lack of buying.  That's what characterizes a bear market.  On the way up, price is all that counts in determining number of shares purchased.  On the way down, unit volume (number of shares for sale) determines whether everyone descends the Hillary Step before experiencing the deathly chill of a bear market.  Here's an update of a table we constructed in the piece describing the sheer number of shares waiting their turn at the Hillary Step for a few of today's investment darlings:         

On the way down the Hillary Step, it's one share at a time.  The Bottleneck is number of shares for sale.  As hard as it may be to imagine, in a bear market each share for sale weighs on price.  As you can see, the increase in the 1990's in units potentially available for sale in the big cap favorites virtually ensures that more than a few climbers will be trapped at the top as inevitably all attempt a simultaneous descent.     

Jomolungma...is the Tibetan name for Everest.  Among the sherpas, it is spoken with respect for the mountain God.  Do investors of today have sincere respect for "the mountain"?  They long to experience the exhilaration of completing ever-higher peaks, but do they have the courage to turn back 100 feet before the summit even if they fully recognize an oncoming storm which would threaten their safety?  Are they cognizant of the bottleneck at the Hillary Step which can cost them precious time in the descent?  Everest is a place where a miscalculation in hours can cost a life.  Experience and humility are the keys to mountaineering success.  Although not quite as dramatic, a miscalculation in risk while ascending and descending the financial mountain can also be quite costly.  As in climbing, long term investment success is ultimately measured and determined by experience and humility.

The Tuesday Charticle...Well, Alan and friends sure showed those pesky speculators who was boss last week with that dramatic 25 beep increase in short rates.  The huge pop in the NAZ, the NAZ 100, the semi index and other tech and Net indices put the steering wheel clearly in the hands of the speculators.  Greenspan may be "the central banker to the world", but US investors know better.  They laughed him off 100 basis points ago.  Tee Hee. 

    Here's where it stands (the fine handiwork of TH):

We either blow or we go.  We guess that the fortunate part is that we're going to know pronto.

The Cisco Kid...We guess CSCO's market cap having increased about $60-70 billion over the last month or so was just a warm up.  It summarily tacked on another $20 billion in after hours antics after reporting one penny better than almighty expectations.  Think about this.  The collective market cap of MSFT, CSCO and GE now approximates roughly $1.5 trillion - about 10% of the entire value of the total equity market.  Like we said, the Hillary Step will ultimately be unforgiving.  Completely unforgiving.  Better enjoy the ascent happy shareholders, because you definitely aren't coming down...alive.

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