Blinded by Science

By Duru

July 7, 2003


I am sure everyone was on pins and needles waiting for the promised missive over the weekend, and I did not deliver! I am now glad I did not because I have the benefit of another monster market rally day to color my opinion.

First, let me say that your intrepid reporter is caught at a serious crossroad. After giving the go-ahead for the speculators amongst you to chase the market upward earlier this spring, my enthusiasm for the market has seriously cooled. I see danger all about, and yet, the market seems poised for yet another leg up. If this leg up happens, even the most hardcore of skeptics will have to declare something truly different (and good!) is afoot.


Yet, this next leg up will be the most dangerous of all. The rally up to now has been based on hopes, dreams, and axiomatic claims on what SHOULD happen in the 2nd half of the year. Every company with a stock ticker symbol was labeled a potential candidate for out-sized growth, no matter how much their business stunk and no matter how emphatically their executives admitted just that. We spent June pretty much stalled out as the market finally took a breath and sifted through the trash and the treasure in preparation for earnings season. And now that earnings season is upon us, the urge to buy is still everywhere. Even though on balance the economic news has been quite mixed, if not downright discouraging. Why is this dangerous? Because this next leg up will REQUIRE actual good news and bullish earnings reports from CEOs this month. If we do not get it, look out below. And even if we do get it, this new rallying cry will be based on, from what I can tell, very temporary rosy signals. For those hopping the train late, the coming correction will be quite painful. For those who got in early, the main pain will be watching those profits melt away that your greed would not let you take to the bank.


I wish I had time to expound, but I will basically say that all the stimulus that the Fed and the Bushies have pumped into the system HAS to go SOMEWHERE. And "go" it is. The liquidity sloshing around in the system is going into homebuying , refinancing, additional corporate debt for the desperate companies, and stocks. We have yet to see whether people or corporations are really buying more with all this money. Time will tell very soon. But after we have drained this stimulus, then what? We are back to 2001 after the first Bushie tax cut that gave us a temporary blip (or hope?) in the economy. We will be left with still too much capacity, too much debt, and not enough disciplined learning from our daze of excess.


Now, I have a confession to make. Saying all this typical bearish stuff is more difficult than ever for me. I already mentioned that I am treading a fine line between gloom and glory because I can see the winks and nods of opportunity ahead. But to make matters worse I just spent a good part of my weekend studying the housing market in preparation for possibly making my own home purchase. Yep, you heard right. Wipe out your ears. This is the SAME Duru talking! After doing this study, I find it amazing how the blinders of self-interested rationalization, optimism, and hope can work wonders in favor of making the decision that harmonizes with your gut desires. You see, I really want to own, but I have struggled to justify buying anything for some time now. With interest rates just about as low as they can go (in fact, long-term interest rates are already creeping back up), I feel compelled to throw my hat in with the landed class. So, while I construct all sorts of scenarios to protect the very real downside possibilities, I truly harbor an optimist's view that somehow everything will be alright and work out just fine. I even found myself dismissing the frightening prospects of California's back-breaking deficits which will have to be paid with crushing cuts in services and painful tax increases. I should be fleeing and looking for safer shores! Indeed, I am a test tube away and a formula short from being blinded by own science!


Given this disclosure, you can see my dilemma. If I truly continue to believe the bearish case, buying a home at this juncture could be quite risky and perhaps there is a better opportunity ahead to time the market. But with every elected official and their aunt trying to pump up the economy with every coin, cash, and bank ledger available, the urge to splurge has become even too irresistible for me. The risk of interest rates rising seem well-enough balanced against the prospect of a significant fall in housing prices here in Cali and counter-balanced by the possibility of inflation alone taking housing prices ever-higher. And this is a microcosm of the dilemma awaiting the economy in the coming months. If a true economic recovery is afoot, this recovery will send interest rates upward. This boost could serve as a break, and perhaps chokehold, on the current housing boom as demand and refinancing practically dries up overnight. It might even encourage money to leave stocks in search of safer yields. Those two combined could stop the economy in its tracks. Whether we enter a new downward spiral will depend upon what people have done with all the money that has been handed out nearly for free. It depends on whether people have saved enough to keep spending in the coming months and years. It will depend upon whether money has gone into capital investments that will produce goods people want and can afford and can produce jobs the more of it that gets bought. It depends on whether the psychology of the economy has sobered up for realistic expectations with healthier balance sheets poised for spending and investing. Something tells me none of these processes have fully worked their way into the core of the economy yet. Ironically, all the easiness from our friends in DC is both softening the blow of a lagging economy and reducing the need to fix the things that need a-fixin.


My science is telling me that we can go either way at this point. My gut (not to mention my scars!) tells me the bear still lurks, and we better be prepared. So, all I can say for now is, again, do not get greedy, take some profits, be ready, and, as always, be careful out there!


Be careful out there!

Ó DrDuru, 2003