MARKET OBSERVATIONS

WHAT NOW ?

    We've put a quick few follow-up (to the obvious) comments and graphs on a separate page.  If you haven't read enough over the weekend aleady, take a peek.  Mania Update 4/15.

MARKET OBSERVATIONS - 4/13

Being somewhat pressed for time this week given the rather dramatic volatility we have experienced in the market, we thought we'd throw around a few random thoughts for your consideration.  What if we are on the brink of the Big One?  What confirms this really is the beginning of a Bear market (forget the percentage moves for a second)?  How might this Bear market be different than those in the past?  There are a lot of questions for which we have few definitive answers, but thought we would explore a few paths of reasoning.  For what it's worth here goes.

The Only Thing We Have To Fear Is Fear Itself...For our regular readers, we have shown you time and again data on mutual fund cash levels being the lowest in three decades.  Just last week we explored current asset allocation levels (of equities) among the public and institutional investors.  We're clearly pushing beyond former historical limits of equity exposure.  In the Tuesday piece we discussed excessive consumer credit exposure and it's resultant side effect of bankruptcies on the part of the public.  We've discussed credit creation by the Fed, GSE debt levels, and the almost incomprehensible levels of derivatives exposure in the US and global financial system.

The one characteristic we simply cannot document or measure is investor complacency or fear.  We can offer anecdotes, but no definitive measure or historical relationship from which to gauge current conditions.  We truly believe that public or group psychology is now of critical importance.  We very well may be standing at the crossroads right now between complacency and fear among public investors.  It's a juncture of paramount importance.  It's the signpost that designates the direction to the next bear market.  It's often said that the Fed has killed every bull market in history.  Partially true.  The real killer is fear on the part of investors.  This time around, the public investor is the one to watch.  The mantra of "you must own stocks" has been ingrained in the American psyche.  It's not broken yet, but when it does break, will outright panic be far behind?

A Tiger In The Tank?...Julian Robertson and the Tiger fund are just the latest in a series of stock market casualties.  We remember a Business Week piece a few years back reigning praise on Robertson (after concluding a few blow out performance years).  Two short years later, Robertson is among the walking wounded.  Is there a timely lesson to be learned from Tiger Management?  We believe there is.  We believe that one of the most pertinent lessons to be learned is that money can move rapidly.  We have to believe that two short years ago, the Tiger team could not have imagined the rate at which they would experience redemptions from their fund(s).  Unfortunately, the experience at Tiger is probably a model for what is to happen ahead for a few of today's mutual fund glitterati.  Remember that Tiger existed in a world limited to quarterly redemptions.  Today's mutual fund behemoths are subject to daily redemptions.  If public fear takes hold and redemptions begin, the lack of cash holdings among mutual fund providers today guarantees immediate asset sales to meet those redemptions.  Tiger lost $16 billion in 15 months.  It came rapidly.  It came without warning.  It came when most would have least expected such a move.  Are the folks at Janus, Fidelity, Putnam, T. Rowe, etc. any different than Tiger in susceptibility?  Given 1-800 number daily redemption availability, the situation is potentially much worse than at Tiger.

"Wall Street Never Changes, Just the Pockets Do"...Once again we are indebted to Jesse Livermore for the simplicity of Street wisdom.  Clearly Livermore meant that the pattern or rhythms of the market remain the same, it's just the faces that change over time.  We could not agree more.  The other "pockets" that change are the pockets of speculation.  The various sectors that come in and out of favor over time that are driven by the collective perceptions of the many.  In the late 1970's mutual funds were loaded with energy stocks.  And why not as these issues had been such wonderful performers in prior period retrospect?  Today it's clearly technology that is this bull market's holy grail.  Have a look at the following table:

Average Share of Equity Fund Portfolios Invested In Technology Stocks (Ranked by Net New Cash Flows)

Source: Morningstar and Investment Co. Institute

The table essentially displays the fact that the mutual funds receiving the most net new money in this country have the heaviest allocations to technology stocks.  Is it any surprise?  Tech is clearly the "pocket" of desire at the moment for all of the new faces on Wall Street (and unfortunately for some of the old faces forced to play the game).  Can this exposure be reallocated on an orderly basis to other areas of the market?  Of course not, but there can be an attempt to reallocate violently.  We may be seeing that right now with what the CNBC's of the world describe as "rotation".

Be Careful, Outright Crashes Are Low Probability Events...If ever there was a time, this just may be it.  (And, no, we have definitively not already experienced a real crash in the NAZ.)  We have virtually all of the ingredients.  The 1-800 number mutual fund redemption infrastructure is in place.  Overvaluation is still at record levels.  Margin debt is revealing its dark side very early in the game.  We could go on and on.  The fact is that outright crashes are very low probability events set against total historical retrospective.  Even for us, it's hard to make that bet.  Personally, we are holding leap puts against the NASDAQ.  We're not going to make 50 or 100x's our money.  We know that.  Watch out when spending your money on near expiration lottery tickets.  Having said that, we thank Tim for providing us a look into the past.  At this LINK you will see a picture of the 1987 crash.  (It may take a minute to load so we put it on the separate page.)  The beginning of the crash period on the chart is strikingly similar to the current NASDAQ.

If the public decides to redeem just a portion of their mutual fund holdings, the equity market is only serving us hors de'oeuvres right now.  The main course awaits.  If this is true, will anyone be left for dessert?  As you know, the main problem in a situation involving redemptions is the concentration of large and broad fund ownership in very few stocks.  Crazily enough, funds like Janus have taken pleasure in touting their concentrated exposure (at least until now).  Just for laughs, let's take a two second look at the big kahuna - Cisco.  As you know, the recent split allowed CSCO to enter the record books as the company having the most shares outstanding in the US.  6.9 billion shares to be exact (not counting stock options, as per normal accounting practices).  Have a look at the following table (holdings as of 12/31/99): 

The top 14 holders of Cisco account for 23% of the total shares out.  On a normal day (whatever that means), average volume is 50 million shares.  As you know, a good portion may be double count.  Assuming it's not (ultra conservative), this exposure represents 32 days of total CSCO trading.  Now which of you funds would like to get out first?   No crowding, please!  We have news for you.  If we hit a period of significant and fast public fund redemptions, this honor roll of funds isn't getting out.  Assuming these positions stayed intact since 12/31, the collective loss of paper wealth for these esteemed guardians of the public trust has been $32 billion in their Cisco holdings alone (from the high on Cisco, not the year end value).  At the moment, the greatest enemy of any bullish investor is his/her next door neighbors.

It's Just Another Day...We have also been struck lately by the lack of alarm in the press, on the tube, etc. regarding recent market action.  This is truly one of the worst technical displays of market action we have witnessed in the last two decades.  We simply can't remember a period as devastating technically.  There has been a lot of paper wealth lost in a big hurry in the past four weeks.  Of course the CNBC gang is doing their best to put on a good face.  The bulletin board cowboys at sites like RagingBull.com continue to view this as the buying opportunity of a lifetime on the inevitable road to fabulous riches.  We were struck today by a mainline site line MarketWatch.com running a story proclaiming that the "The stock market bears are prowling, but they're more growl than bite".  Oh yeah?  Try checking in with anyone who has received a heavy margin call in the last few days.  They've felt the teeth.  The press is clearly telling the investing public not to fear.  What's to worry about?  We've been through this before.  The market always comes back.  You're in it for the long term.  We've always contended that the real selling in the next bear market would not occur until the market was already down 25-30%.  OK, now we're there on the NAZ.  One last thought to ponder.  Assuming that the equity market is approximately $15 trillion in total value, can you imagine what would happen if investors collectively decided that they wanted just 5% of their money back?  Go ahead.  We'll give you 750 billion guesses.

At The Wire...Just before finishing this piece up, AMG reported that $8.4 billion came into mutual funds as of the week ended April 12.  You may remember that four short weeks ago (at the highs on the NASDAQ), we had a record one week inflow to mutual funds with the bulk of the dough being directed to tech funds.  That was 30% ago.  This week, one half of the $8.4 billion went into large cap growth funds and index funds.  Simply typical.  The public chasing whatever had the best performance that WEEK!!!  We were surprised by the number.  The only explanation we can come up with is that many investors funded 1999 IRA contributions.  Crazily enough, this was the largest one week inflow to large cap growth funds in four years.  WOW.  Rally ahead?  Or more dips buying the dip?  We would have sworn that the last hour sell offs in the last two days had all of the earmarks of mutual fund redemptions.  At this point, we're prepared for anything.

Channel Cats...Tim's fine chart work graces the page once again with a view of the SPX:

Following the NASDAQ, the SPX and the DOW have rolled over in the last few days.  If the public blinks, they are all toast.  If not, we'd have to believe the next rally up will be more narrow than most anything we have seen up until now.  To support the markets from here, we do have a potential solution.  How about replacing Intel, Hewlett, Microsoft and IBM in the DOW with Bethlehem Steel, Duke Energy, Berkshire Hathaway and a REIT?  The new new new thing?                

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