LONG clarification on last missive

By Duru

August 29, 2001


Hello everyone!

Yes, again, so soon. After some reflection, I realized that my last missive was incomplete. I was a little too focused on reacting to the market's latest attempt to rob you of your hard-earned money, and I didn't make clear last time what current economic forces are driving the market's latest malaise. Nor did I make clear my own plan of action. This is the longest one yet because I am sitting on a plan right now trying to make this flight fly by. These long drawn out thoughts on paper also help me to check whether my own bearings are still straight. Don't worry...I won't be offended if you choose not to read the whole thing! Here goes...!


When I look out on the economic horizon, I mainly monitor a few things for judging the environment for investing. In my monitoring, I try to ignore specific, isolated events, and instead focus on how things are moving and changing OVER TIME. I have also tried this year to more seriously study the history of the markets because certain patterns, especially when it comes to collective investor behavior, repeat themselves over and over again through time. On the macro level, I am most interested right now in the federal budgeting process, consumer spending, global events, the Federal Reserve's interest rate decisions, market sentiment, and analyst opinion (don't worry, I will explain!). I would be interested in corporate capital spending, but it is dead in the water right now, and its story is well known. I am also not even remotely interested in business inventories right now because inventories do NOT directly measure demand, especially when companies are simply throwing away their unsold products. I just want to know who is buying and what and how much. Finally, I do not care whether we are technically in recession or not. I only care about what the market and economy is actually doing, not how economists define what is happening. Corporate profits remain strongly negative and near-zero growth is sure painful enough!

The Federal Government

The latest wrangling between the White House and Congress over the budget is one of those classic "no kidding" situations. We have known the economy has been slowing down since at least the beginning of this year. I have been preaching until you are blue in the face that the majority opinion on an economic recovery was much too rosy. Unfortunately, the Feds sided with the optimists and based those glorious budget surplus numbers on assumptions of a robust economic recovery beginning about now. With corporate profits in a tailspin, workers collecting less pay, and almost no one making any capital gains from the stock market, Uncle Sam must now face the trickle-down squeeze. The ill-formulated tax rebate has now become a huge loan on the future. Bush is betting that he can use the coming budget shortfalls to squeeze Congress into spending less. History tells us better. Congress's main reason for being is to spend money! And certainly Congress will not stand idly by and starve while Bush tries to spend money on all his pet projects, like the nuclear missile defense system. The coming budget battles will not only threaten Social Security once again, but will eventually re-ignite the government's need to borrow money and drive real interest rates up. This will take time to play out, but it is a serious factor putting limits on future economic growth. Strike one against a robust economic recovery.

Consumer spending and global events

I have probably harped on this too much, but something that makes up 2/3 of the American economy cannot be talked about enough! I just found out that American consumer spending is also 20% of the global economy. Mind you, we are about 5% of the world population. When we stop spending, the whole world takes notice. The world counts on our spending. And so far, we have continued to oblige. Everyone from realtors to sweat shop factory owners remain relatively satiated. However, the long-awaited falling dollar will increase inflation and limit our spending power. Our international friends have a variety of their own problems to deal with. Particularly, Latin America is still on pins and needles praying that Argentina can solve its problems rather than spread them, Japan is mired in a prolonged recession with a stock market that keeps sinking and is at 17-year lows, and European central bankers still think inflation is a bigger threat than economic weakness and they are in no rush to stoke Europeans to buy goods from us or the Japanese. When you put all of this together, it is extremely hard to imagine that any coming economic recovery can be strong and robust. Strike two.

Good ol' Greenspan

I have also harped and mocked the Federal Reserve a-plenty. This year, they have probably been the largest reason investors continue to throw money into the dark hole of "irrational exuberance in forecasting." Until the last 2 interest rate cuts, the Fed kept cheerleading the economy along, thus making every single market bounce up on Fed interest rate cuts look like the beginning of a recovery. The Fed's over-confidence in its ability to first engineer a soft-landing from last year's bubble and then over-confidence in their ability to steer us away from recession caused them be less than forthcoming to the public about the real risks in the economy and especially the risks of using the stock market to bet on that recovery.

Make no mistake. If the Fed hadn't been aggressively cutting rates, the market would have crashed hard, swiftly, and painfully, perhaps as early as January. Unfortunately, the pain has been issued in one extended water torture, spiked with bouts of feverish delirium of stock buying, instead of one lump sum kick in the pants! I find it very disappointing that the Fed does not directly admit that their actions are not only meant to steer the economy but to also guide the stock market: such an admission would help people avoid getting manipulated during every single bear market rally. What has changed recently is that the market has been much weaker prior to interest rate cuts, and is taking longer and longer to respond to the upside to those cuts. This last time around, it took 3 days before the market bounced up! This shows confidence in the Fed is finally waning. The Fed has made matters worse by cutting out the cheerleading and expressing more pessimism (realism?) on the economy's prospects and health. But if they are truly so concerned, why have the cuts now gotten smaller in absolute terms? This whole sad tragicomedy would be a strike three against a robust recovery, but the fact that the Fed has FINALLY gotten a dose of reality stirs up the contrarian in me! Let's given this one a wild pitch at the head.

Market sentiment

Still, with all the carnage in the markets, all the $$$ that has been lost, we have not gotten true capitulation or consistent and convincing bearish sentiment. Market sentiment has not turned to outright fear because people can still pin all of their hopes on the Fed cutting interest rates some more and on the tired adage that the Fed's cuts take 6-18 months to show effect (note well, now that six months have gone by since the first cut and the economy continues to worsen, I hear people now claiming it takes 12 months for an effect. Talk about revisionism! No one dare say 18 months now because it puts economic recovery too far away for anyone to bear right now). The stubbornly high valuations of a lot of key stocks is testament to lingering bullishness in the market.

Why is fear so important? As long as market sentiment is bullish, people maintain low cash positions and buy stocks. For example, I just listened to some analyst/fund manager on CNBC crowing about how people are too short-term and the economy will recover sooner than people think. His bullishness has put him at a ZERO percent cash position. If such a bullish guy has no more money to spend, how in the world can stock prices go up!?!? He of course is trying to encourage us to buy his stocks, but tops are always marked by the bulls running out of money to spend...imagine the problem when all the bulls have run out of money in a sinking market!!! We need more institutions doing what more and more individual investors seem to be doing, and that is, hoarding cash. This happens by selling stock and refusing to buy more. When enough of this happens, we get the extreme in sentiment required to clear out the last sellers and set the stage for a true bull market.

Also be wary of people who say the market is too negative or too short-sighted. I think the stock market IS the economy now. The market is the only thing you need to listen to, not individual soothsayers (except me of course! :) ). And right now, the market is saying that economic recovery ain't happening for at least another 6 months. (Actually, it is hard to say just how forward-looking the market really is. I hear this 6-month rule mentioned when optimistic bulls want to make their case to explain why the heck the market is rising when things look so bad. I never hear them use this rule to say that because the market is sinking, the economy will not recover for at least another six months. It is the classic bullish bias). The market is also saying "feed me, feed me," I want to burn more of your money! OK...all humor aside, the poor performance of the market this late in a Fed easing cycle should start to make long-term investors salivate. If you consider yourself an investor, do NOT ignore the market now. Specific opportunities are there if you look and will surface in greater quantity in the coming months. However, you must be realistic. The US, and likely the global economy, has embarked on a sustained period of stagnant economic growth. We cannot and should not expect any overall rebound to be swift and strong to the upside. In fact, any such market moves, such as last Friday's, should always be treated with suspicion, especially if they are not coupled with some REAL news.

Analyst opinion

You already know how much I despise the bulk of analyst-speak. However, I do NOT ignore it! They can be used very well for contrarian investing strategy. You want to look deeper before buying a stock that analyst's are unanimously negative amount. You should soon consider selling a stock that has unanimous approval from analysts. The former is just to be safe, the latter is the same cash argument. If everyone who is following the stock is bullish and has bought in, who is left to drive the stock higher?!? To a certain extent, this demonstrates just how much of a pyramid scheme stock investing can be sometimes! Enough people still listen to these guys, especially the institutions, that you can often get a whiff of what the crowd thinks by seeing what these people are saying. I have been harsh in calling them idiots, rather, they can be quite shrewd in manipulating popular investing opinion. Unfortunately, their power as a contrarian indicator is diminishing as fewer and fewer people are listening to them, at least not more than for a short-term trade. The reduced influence of analyst muckety-muck is truly a mixed blessing!

One more note on this. I don't watch CNBC a lot, but I catch some of it when I am on the road. I have noticed a possible change in tone on this show that provides blow-by-blow market commentary. It seems that they are finally trotting out more analysts who are bearish on the market or particular stocks. The commentators have a little bit more edge and seem just a tad more critical of optimistic CEOs and analysts who are hyping bullish opinion. Contrarians have gotta love this. If even the promoters on CNBC can ever cry wolf or declare the sky is falling, it will certainly be time to go bargain shopping!

Whew! That was a long one, and I still have 2 1/2 hours of flying time. Thank you for your attention and hopefully this ranting and raving can help you somehow. I think I have now written enough to this point to be able to keep any future commentary brief and to the point! What a relief, eh?

As always, be careful out there!