9/07

I Went Down To The Crossroads, Tried To Flag A Ride...On the rare moments we get to watch CNBC, we usually do so with the sound off.  That way we don't wince so much.  Unfortunately the other day between flipping through morning cartoons (in some circles actually reported to be more intellectually honest and informative than CNBC), we happened to land on "the channel for the next millennium" while they were conducting their "Taking Stock" segment.  One of the stable of leading perma-bull Street strategist regulars was answering caller questions regarding individual stocks.  "What do you think about GE?"  "What's your outlook on Intel?"  (As if there isn't enough white noise out there about this unknown duo already.)  What clearly caught our attention was that each caller question was answered with reference to a stock chart.  Tech stocks that had imploded where "building a strong base".  Comments on tech favorites like Intel were that "it's hitting new highs".  "The chart looks great".  Not once did we hear any reference to earnings, revenues, the balance sheet, backlog, margins, you know, the mundane and boring details that just get in the way of modern day investment analysis.

In homage to the insightful analysis and commentary by the CNBC guest guru, we thought we'd start off by getting right to the chart of the matter in today's discussion.  In our simplistic and childlike reading of charts, the current indices appear to be at a crossroads.  If you laid these charts out devoid of names, we wonder what this strategist would have to say about the following (as you would imagine, of course we interject our own comments):

Not only does chart reconciliation lie ahead, but so does 3Q preannouncement season.  It sure seemed like negative preaanouncements were bludgeoned last quarter and "making the numbers" or "beating by a penny" just didn't have the same panache its had over the last few years.  Is the magic wearing off? 

Fund-amentals...No, we're not here to argue about gross overvaluations again.  Don't you know by now that's meaningless?  Hello?  In conjunction with the charts above possibly suggesting a market approaching a crossroads, especially for the big tech cowboys, we thought we'd have a quick look at where the public has placed their bets over this and the last few years.  Our friends at the Investment Company Institute have recently released their fund inflow numbers for equity funds through July of this year.  Quite illuminating, we must say.  Ready to be barraged by numbers?  Good then, let's proceed.

First the year-to-date 2000 equity fund inflow experience (in $ billions):

The public simply could not buy aggressive growth, growth and sector funds fast enough in the first quarter of this year.  Who could blame them?  Not only had the NASDAQ left the station, it was careening out of control down the tracks.  Either jump on board or be left behind.  As you know, these "types" of funds were largely invested in the techs.  Let's face it, they had to be.  Money flowing into aggressive, growth and sector funds in 1Q came very close to 100% of net new money into equity funds in their entirety.  April saw a bit of a cool down in inflows as the NASDAQ and the S&P were practicing their swan diving techniques in preparation for the summer games "down under".  (In the case of the NASDAQ, ultimately 2000 points down under by May end.)  Since March, we have seen nothing like the monthly flows plowed into equity funds in 1Q.  Oddly enough, even after the heart stopping drop in the NASDAQ during April and May (to say nothing of the historically high volatility we have experienced in 2000), aggressive, growth and sector funds took in 96% of all net new equity fund inflows over the April through July period.  Absolute dollar money flow may have diminished, but not confidence regarding the strategy that the most highly valued area of the market is the place be.  Will this conviction be broken in the next significant NASDAQ swoon?

This confidence primarily in aggressive (read technology) is nothing new to the market in 2000.  It has been building over the past few years.  The numbers are testimony (fund numbers in billions):

Percentage allocations:

The numbers are nothing short of striking.  Aggressive growth funds took in 7% of new equity fund money as short a time ago as 1998, only to rise to 43% of new equity fund inflows this year.  Sector funds (again, read tech) have gone from a virtual afterthought in 1998 to receiving almost a quarter of all new equity fund dollars this year.  Our question is, "who isn't in yet?"  Perhaps more telling is that Growth and Income style funds which received $62 billion in 1998 actually had redemptions of $31 billion year-to-date in 2000.  (Don't worry, it's only a swing of $93 billion from top to bottom, so far.)  Income Equity funds also have seen increased redemptions in 2000.  How else were modern day investors going to be able to plow into tech laden sector and aggressive growth funds at what so far has been the top of the NASDAQ?  It's nothing short of ironic that investors blew out of $47.5 billion in Growth and Income and Income Equity funds during 2000, a year where utilities have achieved one of their best performances year-to-date in literally years.

With prima facie evidence such as this, how can we be anything but contrarian in nature?  (We ask ourselves that daily.)

These numbers give us pause as we combine their message with the index charts presented above.  Clearly the funds and the public have it all on the line in terms of big cap growth and tech stocks.  They are fully loaded.  In our mind, the summer rebound in the NASDAQ, the S&P, and the Dow lulled a lot of investors into some pretty hardcore complacency.  The VIX (OEX Volatility Index) Index we showed you a few weeks back screamed complacency.  The VIX does not preordain that the market has to fall or rise, it's just a gauge of sentiment.  Nonetheless, it portrayed an average investor pretty darn sure that all was more than well in stock land.  It will be quite interesting to see which path the indices decide to travel in the next few weeks/months now that they appear to have reached a pretty clear crossroads.  We have the sneaking feeling that should the NASDAQ back off from here in any significant manner, aggressive growth, growth and sector funds may be facing something completely different - redemptions.  Fool me once, shame on you.  Fool me twice, shame on me.

Attack Of The 50 Foot Woman...It's no secret that a handful of mutual fund families in this country take in the lion's share of cash inflows.  Fidelity, Janus, Putnam, Vanguard, you know the names.  Given the incredible inflow of fund contributions to aggressive, growth and sector funds, just what do you think they own?  As you know, the S&P weighting in technology is currently one of the highest in history.  Roughly 30+%.  On par with the weighting in oil related issues during a funny little time in 1980 (at the very beginning of a huge bear market for energy stocks).  To achieve above average benchmark performance, an institutional overweight in tech has been mandatory.  In sympathy with the current view of the index charts and our discussion on the complexion of equity fund inflows over the last few years, we thought we would present another little example of potential imbalance.  Wouldn't you just know we'd pick one of the current poster children for the networked new era?  As with many of today's popular, momentum driven, must-own issues, a handful of mutual funds dominates the institutional ownership of Sun Micro.

If for some unfathomable reason aggressive, growth and sector funds met the same redemption fate as have current growth and income and income equity funds in the next few years, who would these behemoths sell to?  (The data is from 6/00 SEC 13-F filings.)

To put this into broader perspective, as of 6/00, their were over 1700 institutional holders of SUNW in this country (admittedly many holding small positions).  15 of them controlled 26.2% of SUNW's total outstanding shares.  That's .88% of total holders controlling 26.2% of total shares out.  Together these so far lucky 15 collectively hold over 415 million shares of the company.  At current average daily volume of 16.4 million shares (much double count, of course), this represents at least 25 trading days worth of total activity, exclusive of everyone else on the planet, naturally.

We just can't wait until our favorite chart loving strategist shows up on CNBC's "Taking Stock" next time so we can call in.  "What's your take on SUN?" Quite bright, until it starts to rain shares at some point.

Euro Trash...Literally.  We're scratching our heads.  With oil pushing $35 per barrel (as you know oil is priced in dollars on the global market), the declining Euro guarantees that the ECB nations will be importing inflation.  The ECB captains of the Euro ship are treating the declining currency as if it were a non-event.  By the way, have you noticed the goings on in some of the smaller Asian countries?  Currencies and economies are getting a bit shaky, to say nothing of financial markets.  How low is low on the Euro until inflationary pressures outweigh the supposed benefits of a depreciated currency in terms of hoped for export growth?  Goldman has had a long standing call of an 80 handle bottom valuation on the Euro.  This laissez faire Euro policy is and will continue to pressure Asian exporters to the US in terms of pricing power.  Are we headed for another international economic "bump" so soon after the crisis period just three short years ago?  We'll keep you posted.      

Leakage...The 2Q bank derivatives report hit the street today.  Too late for any comments at publication time.  Our fingers are smeared with ink now as we plow through the report.  We'll bring you all the details next week.  Certainly you'll see why JP Morgan is "in play" when you see their derivatives book.  We also expect the Fed Flow of Funds report next week.  All the juicy details on credit.  We can hardly wait.  Stay tuned for all the important highlights.