MARKET OBSERVATIONS

We See Dead People

MARKET OBSERVATIONS - 6/13

We See Dead People...The rationalization is starting, as you know.  The point where the dreams of a new era meet with the realities of financial economics.  Much like the current characteristics of the broader stock market itself, new era Net participants are being sniper shot on the periphery of the crowd.  In the big cap forest, the giant sequoia P&G's, Microsoft's, Coke's, Gillette's, EDS', etc. fall with a thud.  These trees crack and topple with a loud report and the forest falls quiet once again.  From afar, the forest appears to remain intact and lush.  As these ancient giants fall, they appear to fall singularly.  They do not take down other trees in their wake as they topple, let alone clearing a noticeable swath of the forest.

Now the new era saplings are experiencing a life cut short.  Given their relative importance against the forest landscape as a whole, they fall without a sound.  Few are aware of their deaths mostly because few were aware of their singular lives.  For the moment, their loss is almost imperceptible against the green texture of the forest.  The only participants who are fully aware of the occurrence of singular death are the employees of and investors in the newly departed Net companies.  They alone have full comprehension of the "sick sense".

The Recently Departed:

These (former) companies are a few of the first trailblazers in forming a new Net sector to be dubbed "dotcom heaven".  We're hearing that Merrill is thinking about establishing an index vehicle.  For the moment, broad market participants have placed very little significance on these deaths.  From the standpoint of investing in technology, are they missing the chance to "see" a conceptual turning point for new era psychology and perceptions?  Only time will tell.

Dead Men Walking?...Certainly those who have already closed their digital doors or filed e-bankruptcy outright will not be the last of their species to succumb to the twin diseases of over optimism and technology evolution.  These diseases are spreading throughout the Net/Tech forest.  In fact, some trees appear vibrant and healthy right up until the minute they topple over.  Other Net saplings begin to exhibit signs of disease outwardly well before becoming victims themselves.  The laws of economics as well as the laws of nature itself are powerful.  At the moment, the perceived cure for the diseases in the Net forest are employee layoffs.  Possibly a successful remedy, possibly not.  Nonetheless, a sign that change is upon us.  The health of the new era is being questioned.  The Darwinian tenant of survival of the fittest is being played out in the Net ecosystem.  Layoffs are clear signs of disease.  An interruption in perceptual evolution:

Tourniquet Time:

Layoffs at the above mentioned companies are a clear example that the cash flow law of the financial jungle is alive and well.  It wasn't that long ago that new era adherents perceived funding for Net ideas and startups to be limitless.  They can now see the edge of the financial cliff directly ahead.  Too many of the companies we mentioned that are either closed or trying to stop the bleeding received some type of funding in the last six months.  That funding is now history.  In other anecdotes of the evolutionary process, the following have either pulled or "postponed" their IPO's in the last 3-4 weeks:  Altavista, Noosh, Click Commerce, eMed Technologies, GMX, Catche.com, Chello, Yes TV, Telecity, Ortus and Deja.com.  With all of this e-carnage developing throughout the new economy, we want to assure you that here at ContraryInvestor we are not about to default on ourselves, lay ourselves off or otherwise demand we shut our doors.  At worst, though, we are probably long overdue for giving ourselves "a good talking to".      

Fallout...The fact that a significant number of Net companies are fading fast sends up a good number of messages.  Are most Net companies sporting flawed business models?  Has venture money been reckless in its seemingly random distribution?  Is e-competition much more fierce than originally believed?  Are broad financial market participants evolving from the capitalization of hopes and dreams to discounting current financial economics in their "new metrics" valuation schemes?  Just like the first phase of a bear market, investors may now be concluding the denial stage in the evolutionary cycle of Net company investing.

The Food Chain...As we have mentioned previously, when a Net company closes the doors, advertising ends, office rents come to a screaming halt, legal services are dropped, and technology hardware purchases cease.  Of course many of these who are public companies watch their stocks crash and burn.  The dreams of zillionaire-dom vanish.  Both for the management and the public shareholders.  During the first phase of what we believe is an evolving bear market for stocks in this country, these marginal enterprises become starved for capital and die.  Crazily enough, investors are slow to look back up the food chain.  These new arrivals in dotcom heaven were the former customers of Oracle, Sun Micro, Cisco, Dell, Intel (indirectly), to say nothing of companies like Exodus, Epiphany, Commerce One, Ariba, etc.  For what it is worth, they do not place orders in the dotcom afterlife, despite broadband availability.  It's just ironic that in the first phase of this bear market, as the marginal business enterprises have been sent packing, investors are taking refuge in the supposed safety of their suppliers.

PP Private I...As we mentioned last Thursday, the well below consensus PPI last Friday was just par for the course in the recent string of "favorable" economic reports from the government.  As you know, the month over month number was 0% relative to the .3% expectation.  We have a hard time believing inflation is zero given the following:

The rate of change in CRB futures prices over the last twelve months simply has no parallel any time in the last decade.  How can inflation be zero in this environment of commodity price increases?

A temporary blip down in energy prices appeared to be the root cause of the weaker than expected number.  Since energy prices have rebounded smartly over the past month or so, this implies the June reading should be much stronger.  The year-over-year change in the PPI at 4% does tell a bit of a different story than the monthly change numbers.  Although currently discarded as a bit of an old era indicator, the capacity utilization rate in this country is on the cusp of the 82% level where both bottlenecks and increased pricing power has occurred in past bull economies.  Have a look:

Lastly, the PPI in finished consumer goods simply does not flash "all is well".  Hand in hand with the CRB futures index and capacity utilization rates, the rate of change in the last twelve months depicts pretty dramatic upward pressure:

One Less Seat At The Party...The little stock market rally begun a few days prior to May month end is quite reminiscent of prior manic acts with the exception that this time around, the dollar has not been invited to the party.  Either its invitation was lost in the mail, or perceptions regarding the dollar may be changing.  If the dollar is weakening because the US economy is slowing, stocks are vulnerable.  Assuming for a moment that the US economy is weakening as rapidly as the recently released government figures would have you believe.  Just how much room does Greenspan have to lower rates with crude prices hitting new highs, commodity prices firm and firmer, clear real world anecdotes of labor/wage pressure, and a declining US dollar?  Answer:  Not a helluva lot.  Not exactly a prescription for a bull market in stocks, now is it?.  

Bucking The Trend In Gold...What do gold and the dollar have in common?  In very rough form, they tend to be moving inversely over the last 2-3 years.  It's not one for one, but the extreme in juxtaposed highs and lows seem pretty consistent.  It's a bit hard to tell in the following charts, but look at the peaks and valleys in the dollar compared with the peaks and valleys in gold.  The are pretty close in relative time sequence.

For those long or interested in being long gold, the movement of the trade weighted dollar seems a close inverse approximation for price trend. 

It only seems logical that gold cannot do better until paper does worse.

Retail Snails And Greenspray Bear Repellent...The economy is heating up.  It's slowing down.  No, it's heating up.  Inflation is dead.  No it's not, it's on fire.  It's warm.  It's cold.  Does any of this change the fact that common stocks are very highly valued relative to underlying fundamental characteristics?  The daily chatter and manic "activity" can be frustrating and confusing.  The news headlines on Bloomberg each day have become the definition of schizophrenia.  Stocks rose as interest rate concerns abated.  Stocks declined as investors fear higher interest rates.  Just stop it!  The .3% drop in the retail sales number today was a bit weaker than expected, but nothing to write home about.  In fact in the early going, stocks and bonds didn't seem to give the number any heed at all.

Today's little snapback rally appeared to be Greenspan inspired as he again sprayed bear repellent at the market.  Pyromaniac Greenspan just can't seem to keep himself from lighting fires (under stocks, that is).  "Most of the gains in the level and the growth rate of productivity in the US appear to have been structural, largely driven by the IRREVERSIBLE advances in technology and its application.  Knowledge, once gained, is almost never lost." Astounding.  Greenspan's "irreversible" comment is nothing short of IRRESPONSIBLE!  We all know there are major flaws in the manner in which productivity gains are calculated.  Why incite the crowd with this kind of spin?  The comment on knowledge must surely be an ironic slip of the tongue.  Clearly, investors of today have all but forgotten the "knowledge" gained in prior bear markets.  Oh well, we guess he did say "almost" never.

As least Fed governor McDonough cautioned against reliance on the optimistic view towards productivity in driving central bank policy.  In a New York speech today, Mr. McD said "it would be foolish to declare victory over inflation.  There is no question that the US economy, especially in relation to the world economy, is beginning to exhibit signs of imbalance and strain."  After all, somebody has to be level headed, don't they?.

Eanie Beanie, Chili Beanie, The Spirits Are About To Speak...The next few weeks may be quite eventful for stock market participants.  We really have no idea what will transpire in the near term, but the potential for volatility seems pretty significant.  The expiration this Friday coupled with the almighty CPI tomorrow may possibly mean that Wednesday and Thursday might witness upside violence.  More importantly, the last week of the month is both the Central Bank variety hour and the month/quarter end window dressing talent show.  Can you imagine a no rate hike scenario coupled with window dressing fireworks in an attempt to "correct" some of the severe stock damage done in this historically, record setting, volatile quarter?  If you can't, we strongly suggest you be open to any possibility.  Both emotionally and financially.  We're not saying it will happen, just that it can.  For what it is worth, if a blistering rally were to occur with the mutual funds investing OPM (other people's money), we'd have to break into the kids' piggy banks to lay down a few chips on intermediate term QQQ puts in a valiant attempt to increase our personal tax loss carryforwards.

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