ContraryInvestor - Market Observations

Due to a prior commitment, we'll be out on Thursday the 6th. Sorry for the inconvenience. We truly hate to have to miss you given the tranquility of the current market environment. We'll be back publishing again next Tuesday the 11th. Best regards...The folks at CI.

Foreshock?...We can't help but make a few direct comments on the market before getting to our little conceptual discussion for the day. We thought we had seen it all. To our regular readers, we apologize profusely in advance for the following table. This is literally the umpteenth time we have presented it. It's just that today, it's important. We have been saying for some time that we had not yet seen the highs on volume or the maximum index daily percentage swings. Today was getting pretty close to what we were talking about. As you know, we are continually strolling down memory lane in search of the future. The table depicting both intra and inter day swings in the Dow prior to 1929 holds very special meaning today. Have a good look:

DATE	Daily % Change	Intra-day % Range	Date	Daily % Change	Intra-day % Range
9/4/29	(0.4) %	1.0 %	10/8	(0.2) %	2.5 %
9/5	(2.6)	3.9	10/9	0.5	2.9
9/6	1.8	2.5	10/10	1.8	2.9
9/9	(0.4)	2.5	10/11	0.0	2.6
9/10	(2.)	3.9	10/14	(0.5)	2.6
9/11	1.0	2.4	10/15	(1.1)	2.4
9/12	(1.2)	3.3	10/16	(3.2)	3.4
9/13	0.1	2.7	10/17	1.7	3.3
9/16	1.5	2.4	10/18	(2.5)	3.2
9/17	(1.0)	2.2	10/21	(3.7)	5.5
9/18	0.6	2.3	10/22	1.7	3.4
9/19	(0.3)	2.0	10/23	(6.3)	8.0
9/20	(2.1)	2.9	10/24	(2.1)	13.2
9/23	(0.8)	2.6	10/25	0.6	3.5
9/24	(1.8)	3.6	10/28	(13.5)	14.8
9/25	0.0	3.0	10/29	(11.7)	18.5
9/26	1.0	2.4	10/30	12.3	13.4
9/27	(3.1)	3.2	10/31	5.8	8.9
9/30	(0.4)	2.4	11/4	(5.8)	6.6
10/1	(0.3)	2.8	11/6	(9.9)	11.4
10/2	0.6	3.1	11/7	2.6	10.5
10/3	(4.2)	5.1	11/8	(0.7)	4.5
10/4	(1.4)	3.9	11/11	(6.8)	7.3
10/7	6.3	7.2	11/12	(8.9)	8.9

Much like the foreshock in a Silicon Valley earthquake, the current market volatility has been increasing day by day, month by month, since the beginning of the year. Record after record NASDAQ move has been recorded this year. What is nothing short of eerie is the action of the NASDAQ over the past two days compared to the action in the Dow just prior to the beginning of the plunge in 1929. We have highlighted the days in the table. Yesterday, the NASDAQ had an intra-day swing of close to 8% and closed down almost 7%. Today the intra-day was 13.7% and the close was a -1.8%. This is almost identical to the Dow in the days prior to the '29 crash. Will it happen again? Just stick around and we'll all find out. (Don't worry too much as today is nothing like '29. Back then we had no trade deficit, a positive savings rate, the public were not participants in the stock market broadly (remember, most were farmers and labor), debt as a percentage of household income was at much, much lower levels, and credit was not generally available in mass quantities to anyone with a pulse. Lastly, and most importantly, we didn't have instantaneous decision making power via the Internet.) In the words of the immortal Dr. Evil, "quite interesting, really."

Who' Left To Buy?...We're not talking about corporate mergers and acquisitions here, we're addressing the question of "who is left to buy equities?". The common wisdom on Wall Street these days seems to be that there will essentially be a limitless supply of buyers (and money) available to purchase equities as far as the eye can see. After all, didn't today's action reinforce that mentality? Anyone doing any thinking at all knows that this is absolutely not true. In fact, one look at the NYSE and NASDAQ Advance/Decline lines, and it is clearly apparent that the bulk of the money destined for equities in this historic bull market has already been spent. The many have to perish to support the few (the index heavyweights, of course).

Nonetheless, the Harry Dent's of the world run around proclaiming that the demographic time bomb explosion of baby boom hopes and dreams (and supposed money) will keep equities rising for at least the next decade. "Don't worry", is the message. Just stay long and relax. As we understand it, Japan's baby boom is about 10 years ahead of our own. In fact, many of the same Dent-ism's were bantered about in Japan just 10 short years ago. The Japanese public was saving like there was no tomorrow. They were investing in Japanese equities weekly. The boom was destined to continue given the in place Japanese demographic tidal wave at the time. Oops!! What happened? (We wonder how many speaking engagements Mr. Dent has had in Japan lately?) As you know, Harry Dent explains bull markets as being driven by demographics. Alternatively, we humbly suggest it has nothing to do with demographics and everything to do with money and credit creation. For the public's sake, let's just hope the Roaring 2000's don't turn into the Screaming 2000's.

Asset Allocation Heading Toward The Wall?...It's actually been in the press lately that many large public pension funds are planning on modestly cutting back on equities. Is this "new era" blasphemy? Have they been listening to Abby? Far from it. Equities as a percentage of total assets have simply grown too large. After all, public plans, private plans, life company's and trust operations are fiduciaries. No matter how much they are drooling over stocks, they have to answer to the Prudent Investor Act. Once again, courtesy of the Federal Reserve, the data is right out in plain sight for all to peruse. Of course, the folks at CNBC must not know the Fed's web site address.

Clearly, we are pushing the highs seen just prior to the 1973 market break. As you know, in the case of mutual funds, fiduciary responsibility is simply a moot point. It's the public voting machine in action. It's also the need of each manager to "guess" what his/her peers will/are doing. Sometimes relative performance causes people to do things that have absolutely nothing to do with investing. As you know, this just happens to be one of those times.

The percentage allocation seems low because this particular graph does not take into account pension, profit sharing and 401(k) accounts. Don't worry, you'll get a taste of what these are like in the graphs for mutual funds, and public and private pension assets. We're above where we were in the last equity mania in the late 60's/early 70's. It's just a rotten shame the public had so little allocation to equities at the start of this glorious bull market in 1980. Then again, it has to be this way, doesn't it? Also, as you know, we happened to have a positive savings rate and lack of massive trade deficit the last time mom and pop held this much of their assets in equities. Then again, it has to be this way, doesn't it?

The chart on Life Insurance Companies is pretty wild. Remember, we now have such wonderful life products as variable (translation: stock exposure) whole life and annuities. Since both of these products (in our minds) are sold to, and not bought by consumers, the life companies have done one heck of an overall sales job. (The wonderful power of commission-based sales in action.) Of course in today's world, who would be stupid enough to settle for a guaranteed 6% on a whole life or annuity policy? You'd have to have rocks in your head when you can buy the NASDAQ at 225x's earnings!

Those big public pension funds have not missed a beat in this bull market. Well, they did miss the first ten years or so, but they've made up for lost time with a vengeance and have been fully invested for the mania portion of the event. (By the mid 1990's, most of the old time public fund administrators had "retired", thank God.) As we described, these funds really are limited in terms of how far they can push equities as a percentage of total assets. This chart clearly suggests to us that they have hit the wall at roughly 75-80%. As a matter of sheer fiduciary responsibility, they are not going to 100% equities. They simply can't. Since many of these plans are fully funded, there is little need for the States to kick in big additional contributions as they had in the past. After all, the market is doing it for them.

What will these plans do with incremental moneys that come aboard? We'll it's just a good thing that the venture capital conduit is so wide open and hot right now. They can pile incremental moneys into VC funded dot.com companies. Yeah, that's the ticket. The only downside we can see to investing in "alternative assets", as VC money is called by the consultants, is that there is no tax benefit when the dot.com's file (Chapter 11, that is). Otherwise, full speed ahead.

The private pension plans face much the same fiduciary responsibilities as the public plans. More importantly, with so many private plans fully funded and over funded given the largesse of the bull market in equities, why take the risk of buying more equity? Clearly, the greater issue is to limit future corporate cash contributions by limiting investment risk with each incremental dollar of inflow or gain.

These charts really say it all for us. We clearly believe that the large public and private pension funds have hit the asset allocation wall in terms of equity exposure. Moreover, mutual funds, household investment and life exposure to equities (via variable insurance products) is constrained by the public's ability to put in more money. With household credit at simply astronomical levels and the public (negative) savings rate bumping along at the lowest level in US history, we have to question how much more is there to give? Of course there are always incremental dollars, but it sure appears that the bulk of personal investment flows to equities have already occurred.

The last significant source of money for equities that we can identify would be from foreigners and the US corporate sector (stock buybacks). Lately, it seems that foreign demand has been a truly big source of new money given the simply mind boggling trade deficit the US now runs ($1 billion daily at last count.) The dollar "recycling" program has to be a big factor in the large cap stock out performance over the last few years. In the last year alone, foreign buying of US equities has totaled $210 billion. At the margin, that's a good chunk of change. Our one observation on this is that foreigners have shown up to the US equity party at the last minute. Moreover, foreign money will be "hot" in any US equity market or severe dollar downturn. Days like today simply do wonders for foreign confidence in US financial assets. Just trust us.

In the last two years, corporations have purchased $270 billion in equities, largely their own. Stock buybacks have been hot and heavy, many driven by the desperate attempt to prop up corporate earnings. Now we have higher interest rates, leverage in the corporate sector like never before, and faltering equity prices for the broad stock market. Does this sound like the perfect environment for continued stock buybacks? Just ask shareholders how they would like their cash spent/wasted? Have you ever heard the term "averaging down"? Well, get used to it.

Where Do We Go From Here?...It sure appears to us that demand for US equities has been largely satiated. Likewise, the corporate and foreign demand of the last few years must be considered an anomaly as opposed to a sustainable source of demand. We have one question for the Harry Dent devotees of the world. Just who is the next buyer of US equities? (It sure appears that the public, the pension funds, corporations and foreigners have already pigged out at the trough. In fact, they are unloosening their belts a notch as we speak. Alka seltzer anyone? Step right up you NASDAQ heartburn victims.)

What we see is that the most undesirable source of demand imaginable is moving equities now - that is, margin debt. Greenspan knows this too. He's not stupid. In the last two quarters, public and so-called professional investors alike have tossed aside "old economy" stocks to purchase the beauty contest queen "new economy" stocks. They can't do both at the same time anymore. Clearly the last few weeks stand as testament to this fact. There isn't enough money. This is a clear and present example that there is simply not enough money left to support the entire game. No matter how you slice it, outside of credit driven money creation, the funds needed to support and sustain stock prices broadly are simply running out. The time is drawing near when Econ 101 delivers its ultimately harsh message to the "new era" investors of today - upward price is a function of continually increasing demand. After all, stock prices don't magically go up by themselves. You'd simply be surprised how many of today's newbie's just don't get that...quite yet. Before it's over, we have the feeling they will become experts in many of the basic concepts of academic economics. We always knew the Internet would be a perfect vehicle for distributing educational materials.

Dial "M" for Margin...Tim's chart work continues to hit the marks. In last Thursday's chart of the NAZ, Tim foretold that if the NASDAQ broke 4450, a minimum target was 3,700. Little did he or we know that he would be proven correct in 24 trading hours.

Today's action was clearly sensational. Do you really think the move off of the lows was due to dip buyers? Or could it possibly have had anything to do with the $9.5 billion coupon pass conducted by Uncle Al and friends this morning? Despite the so-called recovery, breadth on the NAZ was 3 to 1 negative and on the NYSE it was 2 to 1 negative. Not exactly a broad recovery, we must say. A boatload of financial and technical damage has been visited on the "new era" investors. We'll just have to see how this shapes perceptions and actions ahead. One of these days, the bungee cord holding up the NASDAQ, DOW and S&P is going to snap.

Government Intervention...We'll never actually be able to prove it in stocks, but the American public is P.O.'ed that it's happening to St. William Gates. We caught many a news report today portraying the public directly blaming the government for being heavy handed with Mr. Softie. We have the feeling what the public is really pissed at is that the government negatively effected their stocks. You know and we know that the MSFT situation is pretty much a side show in the greater speculative drama being played out in this nation. It's just a preview that the public will be looking for someone to blame when the financial mania finally breathes its last.