The final disgrace

By Duru

September 28, 2003


I tried, I really tried! I wanted to hold my tongue about the latest building dramas in the financial markets until mid-October or so when I presume they will come to a head, but I simply could not resist. As usual, I appreciate you humoring me for a second or two (well, in this case many minutes)...


Typically, I would have titled this kind of piece with a question mark ("The Final Disgrace?"). However, I want to take a little more of the optimistic side and claim that we are at last witnessing the beginning of the final cleansing of the poor financial governance that our financial bubble inflicted upon us. I certainly hope that one day we will look back at the fall and disgrace of Dick Grasso, the now booted CEO and Chairman of the New York Stock Exchange (NYSE), as the death knell of the good ol' greed and corruption that climaxed with the bubble. I hope that we will look back and marvel at how well we brought the madness under control and ushered in a new era of the more "controlled" type of greed that typically marks our economic system (sorry - I could not but help make a smartie-pants swipe on that one).


I found it quite fitting that the market celebrated Grasso's departure with a massive rally the following day, as if to register its approval. And let us really take a pause and remark this moment. Grasso was one of the largest symbols of our financial markets (although very few people truly understand just what he REALLY does!). Grasso was a man made even more mythical by his artful negotiation of the 9/11 crisis. And yet, none of his super-powers could defeat the Kryptonite that the ostentatious display of greed has now become. Notice, it was not the NY state attorney general Spitzer, Congress, or even the SEC that finally knocked Grasso out. It was his OWN boys! The very directors and other assorted rich folk that put Grasso on his pedestal in the first place, lavish pay package and all. They have made a statement amongst their own culture of money that things are truly going to have to change. We are witnessing rich, fat cat, power brokers, ganging up on another fat cat (albeit self-made fat cat) whose greed was put on display for us to witness in all its shocking glory. During the bubble days, people would have been too busy cashing in their own tickets to stop to pay attention. At least from a symbolic point of view, this is bigger than all the previous financial scandals we have had to endure in this post-bubble period.


Now, the cynical will say the culture of money will simply become better at hiding their greed and corruption...and certainly there is some of that already going on. After all, Grasso did nothing illegal. He earned his money fair and square, and his buddies are probably having sour grapes because they did not figure out similar schemes for themselves. The indignant floor traders were probably more upset because their high fees were supporting Grasso's fat pay package. But the more important dynamic to monitor is how our economic system comes to peace again with its own inherent avarice and brings back in controls and checks that prevents the system from spinning out of control (as it did during the bubble). The Bushies need to take note of this historic moment because they may soon find that none of Bush's supposed heroics of the post-9/11 era will matter when people are worried that the country has gone astray and teeters on financial ruin - when his own partners in corporate America sense that it will only get harder to make a buck under the current regime. But I will save my typical Bushie tirade for a little later on....


If you recall from earlier missives, I pounded the table insisting that the tone and nature of trading in the stock market the first workday after Labor Day sets the tone for the rest of the year. The historical record from at least the late 80s onward told me this. And for a while, things seemed all good, even after those early gains were first wiped out in the middle of the month. We are now in the middle of the most serious correction since this current bear rally began in March. When you look over this stretch, the current malaise is but a pinprick in the gains clocked to date. What is different then is the speed, intensity, and depth in which the market has turned. I am seeing a battlefield littered with broken down stocks or stocks on the verge of a breakdown (for those of you who are technically-minded, this means that a lot of stocks from my vantage point have broken below critical support levels on heavy selling. Indeed, the charts of the Dow, S&P500, and the S&P small-cap index are ringing similar alarm bells. The Nasdaq is right on the edge). Typically, I would be in "chicken little" mode and insist that this is just the beginning of a big crash. However, things are a bit different now (=gasp=!). First, of course, is that I am shying away from firm predictions for now because I see so many conflicting signals telling me that things could easily go either way here. But more importantly for the short-term is that it still seems to me that there is enough juice in the tales about a robust 2004 economic recovery to get the believers buying into this correction. After all, as long as that recovery story does not change, a lot of bargains are beginning to reveal themselves.


What I WILL caution you about is that even if we will soon right the ship, there is simply no telling how deep this correction will go before the previous upward trend resumes. This means that buying here for more than a quick trade should be supported by a belief that buying at even lower prices will be an even better clearance sale and opportunity for more riches rather than a time to curse yourself about being "wrong." From a pure price level, I am most concerned that the market has now wiped out its September gains TWICE and is currently eating into the gains from August. While I did notice that ONE reversal of fortune in that post-Labor Day historical record seemed typical, I do not think I witnessed double-reversals. Such action can signify the slow formation of a real top. I will not predict a top here. Just note this as a red flag.


Those of you with memories might be wondering, "Now, Duru, weren't you predicting a big fall in the Fall?" Ah, you caught me! I did indeed! However, I softened that bold prediction to say that we should see the typical Fall correction, but it won't be nearly as deep as I think is justified, nor as far as most bears are certainly wishing for. Again, the fundamental beliefs that support buying stocks here are largely intact. We have just had some recent news about the potential future weakness in the dollar and rising oil prices that have provided excuses to those who are anxious to lock in their gains (the "profit-lockers") for their fiscal year reporting. On the flip side, few seem to notice that interest rates have started coming back down (despite the growing risk that a devaluation of the dollar will drive these rates up), typically, an excuse used for BUYING stocks. Given the season, I am sure bad news will continue to get more air time than good.


The "performance chasers" are still out there, eager to buy. These are largely the pros that have lagged the indices badly all year due to their skepticism about yet another bear rally. Time is running out for them to catch up and a nice little dip could be just the medicine they need. The battle between the profit-lockers and the performance-chasers have created some sizeable moves in the market. I argue that it will take some truly BAD (like in big bad bear) news to really wipe out the underlying bias to buy this market. Excluding big external shocks to the system, it just does not seem like this kind of bad news will happen until the 2004 economic recovery tale is proven wrong. And, heck, the spinsters might find a way again to delay the premiere for the robust economic recovery into the second half of 2004 without causing panic (and thus giving Bush the best chance of re-election...again, I digress). As I have noted before, the Fed and company did an excellent job of turning just such a trick when transferring their optimism from the second half of 2003 to the first half of 2004.


So what kinds of things COULD blindside the market? Or better yet, what kinds of negatives might the market finally decide to start pricing into stocks? Well, this is where I will allow myself the periodic Bushie tirade. More and more polls are showing the support for Bushie and company continues to decline. The latest revelations about the poor quality of our "intelligence" (don't get me started on that one) used to justify invading Iraq seems to FINALLY be getting the point to people that maybe, just maybe, our whole incursion into Iraq was a sham, a shame even. Heck, if I were the CIA, I would not have put much effort, resources, or even lives at risk on this kind of intelligence when I knew the Bushies were on a pre-determined path for war and just needed to dig up some excuse to justify it. Anyone notice how Powell and Rice are now lying low? The Bushies must be cooking up a grand scheme to construct a bunch of fall guys (and gals) that they hope will ultimately protect the President from direct blame for this mess. But will anyone believe it by then? Will the country have finally become cynical and distrusting enough to decide it is time for regime change in the US?


Earlier, I claimed that the market could be starting to worry about a Bush-less White House. He seemed like such a shoe-in before. The market typically does not like such growing uncertainty. If the Democrats continue to promise to unravel all the special goodies that have helped goose up this market in the first place, you create an even more fearful market. Now, of course, I am biased because I never supported the war in Iraq (although I did support the incursion into Afghanistan), and I am anti-Bushie, so I am quick to jump on news that bolsters my criticism of this whole charade. I will admit that. But I still continue to marvel at how slowly the indignation grows over this whole episode. Were people not incensed to learn that the EPA WAS lying after all about the toxicity of the air in NYC in the days following the terrorist attacks? Are people just so mortally fearful of terrorism that they are willing to "play it safe" and go with questionable governance that in the short-term can kill and destroy on a massive scale and hopefully kill a few terrorists in the process versus uncovering the policies that in the long-term can root out the fundamental causes of our problem? I can only look back to Grasso's downfall as some hopeful sign that people are willing to wake up and tell their own that enough is enough - the most powerful message of all.


What is WORSE from the market's perspective is that America is becoming increasingly isolated on the international scene. We have withdrawn from major international treaties, we have declared to the world that you are either with us or against us, we have insisted on bombing who we please, when we please. So, is it a surprise that when we had the NERVE to ask the world for help in cleaning up our mess in Iraq that our pleas largely fell on deaf ears? Even our British buddy Blair is in serious political jeopardy over his willingness to blindly follow the US around in its bombing runs. Without reinforcements soon, our 140,000 or so troops in Iraq look more and more like they are loitering rather than truly occupying a subjugated land. So, add isolation to an escalating cost of supporting our mission in Iraq for some indefinite amount of time. But, hey, it may have been our intention to stay indefinitely anyway in order to build a credible and effective base for taking out the rest of our "enemies" in the Arab world and creating a democratic paradise. When the International Atomic Energy Agency (IAEA) recently found more traces of weapons-grade uranium in Iran, surely the markets shuddered to think about the prospects of yet another expensive war in the Persian gulf. If we took out Iraq with little to no evidence of weapons of mass destruction, what will (should) we do when the real deal shows up in those oil fields we need so much? And what about the lunatic in North Korea playing with his own red button?


Whew! Thanks for indulging me. I really needed to get THAT one out! :)


I will wrap this up with some immediate observations - as opposed to some bold predictions. This current correction has come just as many analysts were finally getting bold enough to hike up estimates of the earnings of speculative technology companies and justify valuations based on projections into 2005. Justifying this courage, at least partly, had to be the fact that the amount of earnings warnings is running lower than we have been used to in the recent past. I found the following quote: "As of Friday (9/12), there were 446 warnings of profit shortfalls this quarter, down from 468 this time last quarter and 485 a year ago, according to Thomson First Call. Happier surprises rose to 267 from 226 last quarter and 215 last year." However, watching a market go nearly straight up for six months, and to be at 12-18 month highs, has a self-reinforcing feature. People bid the market up because they assume the worst is behind us, and people assume the worst is behind us because the market is up so strongly. I have previously talked about the "set-up." That set-up may have been wrapped up and is poised and ready to spring. You see, a benign market has the soothing effect of making people think their is no risk in stocks. A market that sharply rebounds from corrections, helps people believe that the market "always comes back." We have seen both in the past 14-15 months or so giving plenty of time to start erasing people's memories of the pains of the bear market. During this period, the market has arguably been no better than "fairly valued" and often over-valued. I believe valuation wins in the "long-run." Until reality strikes, there is certainly opportunity to ride the wave. You can enjoy it if you recognize it for what it is. In the meantime, be clear about the timeframe over which you are willing to take this risk.

Until the next drama....!

Ó DrDuru, 2003