MARKET OBSERVATIONS

NO FEAR !

MARKET OBSERVATIONS - 3/2

As can be seen, the VIX spiked into the mid-30 range last October when the averages were near their lows.  It did a pretty good job of spotting/predicting the near term bottom at that time.  Of course a coincidental huge jolt of monetary java from the Central Bank fan club didn't hurt much either in creating the "buying opportunity" bottom.  Longer term, the track record is even better. Take a look at the last four years:

Clearly the semi-panic lows in 1997 (Asian economic crisis) and 1998 (Russia and LTCM Capital) registered strongly on the VIX Richter scale.  A move to and above the 40-50 range is seldom seen and can, under normal circumstances, indicate a possible low point in market averages.  Or rather, a point  of definitive fear among investors.

What we are arguing currently is that this market still shows NO FEAR loudly and clearly.  In our view, the bottom is not in by any means.  It strongly suggests that the market moves lower before some type of bottom can be put in.  As you know, we are clearly talking about multiple markets in today's world.  It's basically tech and everything else.  The VIX primarily addresses the S&P and the DOW (given the similarity of holdings in the S&P 100 - the OEX).  The big cap techs are included, but it's in no way completely reflective of the NASDAQ singularly.  It seems somewhat amazing that a GE can drop 35%, a JNJ can blow 35%, a WMT down 30%, etc., and an overall DOW and S&P move quickly down double digits from their highs of this year without stirring up the VIX a bit more than usual.  To us, the answer lies in complacency regarding tech.  The perception has to be that as long as the tech stocks are OK, the bull market overall is intact and on firm footing.  After all, investors have been conditioned for almost two years now to ignore everything except tech.  How else could the Advance/Decline line of the S&P and the NAZ have sunk slowly into depressions without causing the retail investor at large to blink (to say nothing of their institutional brethren)?

Wanna hear a fun fact?  On Tuesday, four of the five most active stocks in the market were issues priced under $5.  Three of the five were up over 50% on the day.  How else could one explain the incredible moves in bulletin board issues outside of mind numbing complacency on the part of the investment community (and we use that term very broadly)?  Take five parts complacency and mix with ten parts insatiable greed.  Clearly do not shake well as this new concoction is called the Lit Fuse.  (They'll be plenty of time for shaking later.  Maybe the more proper term is trembling.)  The low VIX reading in the face of declining market averages and submerging former(?) big cap favorite darlings clearly says that investors in aggregate are not scared in the least.  Being the new age technicians that we have now become, the Dow and the S&P will not have bottomed until we get a VIX reading above 35 and spiking inter-day action in the VIX.  That's fear, and folks we ain't there yet.

NO FEAR (Part II)...It's not just in their investing (?) "activities" that the public exhibits no fear.  It's also in the "real" New Economy were actions speak much louder than words.  In the New Economy, the word fear isn't even whispered.  (It's quietly been dropped from the New Webster's Dictionary, by the way.)  Despite oil prices tripling in the past 18 months (now at a nine year high), the economy is accelerating.  Despite mortgage interest rates up 150 basis points in the last 18 months, construction spending rose 2.7% in January (the largest since last June).  The Mortgage Bankers Association reported a 5.6% increase in mortgage apps last week despite mortgage rates being the highest in almost half a decade.  Despite higher credit card interest rates, consumer confidence numbers barely blink and are close to their highest levels ever.  Despite higher cost auto loans, Ford, GM and Daimler Chrysler report higher February car sales.  With unemployment numbers running near three decade lows, surveys of corporations indicate strong hiring plans for the year ahead.  The suggested conclusions that seem to leap forth from these facts are as follows:

    Fed actions over the last year were completely ineffective in slowing the economy.  Too little too late in each rate hike.  Falling further behind all the time.  By taking the gradualist route, interest rates will have to move significantly higher before this New Economy finally "gets it" (in more ways than one).

    Injections of massive amounts of credit/money are felt with lag effects one to two quarters later.

    The stock market is the driver of the real economy for the first time in possibly two generations (as opposed to the economy driving the market).  The direction of the stock market will determine the future of the real economy in the "new era".

    There is simply no desire or will to arrest wanton speculation in the financial markets (which will ultimately undermine confidence at some point in the market mechanism itself, for possibly a generation to come).  

At the peaks of the financial markets in the US in 1929 and Japan in the late 1980's, the economies of each country were in full bloom.  Unemployment low.  Inflation supposedly low.  Interest rates rising, but not a concern to financial market participants.  Corporate earnings cooking along.  And widespread usage of the word "new" (era, market, economy, environment, you name it) was heard far and wide.  In a recent piece, Barton Biggs pointed out a little nugget from one of Ravi Batra's books.  "Children are destined to repeat the mistakes of their grandparents, not their parents."  Intuitively this makes a lot of sense.  It usually takes a generation to wipe away the memories and make seem distant the experiences of our forbears.  In today's world, this simply could not be more true.  In the financial markets, it seems right on the money.

Is Everyone In Yet?...The recently reported mutual fund numbers are nothing if not staggering.  First, January 2000 was a historical record for mutual fund inflows.  $28 billion is the number.  Possibly flow is inaccurate.  Deluge sounds more like it.  How ironic that we set a record for inflows and experience one of the worst January Dow showings in almost half a century.  Maybe not so ironic.  In January, $28.1 billion went directly into sector (tech, of course) and aggressive growth (tech, of course) funds.  In doesn't take a genius to figure out that all other "styles" of funds experienced net redemptions.  Growth and Income funds experienced $7.6 billion in redemptions.  Net outflow from bond funds was $12.6 billion.  Conversely, Global and International Funds experienced inflows of $12 billion.

At this late stage in the market cycle and economic cycle, investors have wisely chosen to pile into the most speculative stocks they can find.  The higher speculative sectors of the market rise and the more money that chases these sectors, the more that risk as an investment consideration is abandoned.  Today's investors throw money at press releases using phrases such as "e-commerce strategy", "B2B opportunities", etc.  Many of these supposedly new age investments are nothing more than shell bulletin board companies whose core area of expertise are press releases.  Unfortunately for old era companies like Johnson and Johnson (who have just lived through a two month 35% decline in market cap), the only feeble strategy or opportunity they could muster is one that centers around the simply outdated notion of profitability.  We ask you, where is corporate governance in all of this?  Doesn't JNJ's Board have a fiduciary responsibility to chase an e-commerce strategy at all costs and to the exclusion of current fundamental operations?  We smell e-class action in the making.

Peak Performance?...We're stretching the outer limits.  Don't take our word for it.  Let Tim's fine chart work do the talking:

The calibrated comparison between the "new economy" NASDAQ and the "old economy" (new at the time) Dow of 1929 is a bit striking.  The NAZ is working its way toward a quadruple off of the late 1998 low.  What a difference 18 months can make.  It's like a whole new world.  There's only one tiny snag.  We have seen very few parabolic charts in our time that did not resolve themselves the same way.  That's the hard way, of course.

    "Children are destined to repeat the mistakes of their grandparents, not their parents."      

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