September 12, 2004
Although the market has mainly trended downward this year, particularly in tech, most of the signals that the market consumes have looked mixed. This latest economic recovery appears to be very lopsided. Bushie's tax cuts have succeeded in helping companies (in general) become very profitable again and the rich are once again comfortable spending profusely. On the other hand, the middle-class and especially the working poor continue to struggle with sluggish job growth and stagnant wages. One quick attempt to see this phenomenon at work is to compare the stock performance (really financial performance) of luxury goods companies like Movado, Nordstrom, Neiman Markus versus companies like Wal-mart, Dollar Tree, and Family Dollar. These comparisons end up being very rough comparisons though. It is likely that you can find enough stocks within each group that are working against the presumed trend to make you doubt the original premise. I like to absorb the comments from the company executives as they report results. Furniture Brands's comments last week are very instructive: "Company-wide, our incoming orders were modestly positive in July on a year-over-year basis and essentially flat in August. We are encouraged by the continuing strength of orders at the upper price companies, but we continue to sense caution among consumers at the middle price points, as high oil prices and uncertainties in the job markets are appearing to affect overall confidence." (Briefing.com) Trickle down economics seems to be failing yet again.
Another feature of the mixed recovery is the dogged determination of failing companies to hang on despite every sign that the game has already ended. I was struck by the following news last week from one failing telecom company: "CoSine Communications, Inc.…announced that after an extensive evaluation of strategic alternatives, the Company has initiated actions to lay-off most of its employees in September 2004, retaining a limited team of employees to provide customer support and handle matters related to the ongoing exploration of strategic alternatives. Management and the Board of Directors concluded that maintaining the Company's existing employee headcount was not necessary for any of the strategic alternatives currently under consideration and the ongoing employee-related expenditures could potentially decrease total stockholder value." ("CoSine Communications Announces Headcount Reductions, " September 8, 2004). Of course, this is a thinly veiled warning that the company continues to generate little to no new business and is on the verge of bankruptcy. It seems over the last 6 months they generated $17 million, a drop of 15% from the previous period and net loss increased to a whopping $17.1 million. They are now down to $44.4M in cash and obviously are finally facing the grim reaper. But the only reason why they have managed to slug it out for roughly four years as a public company is that the technology bubble that first burst in 2000 is still slowly working its way through the tech jungle. So much cash was snatched from unsuspecting investors during the bubble that countless companies have been able to glide along on fumes for quite some time. You need look no further than CoSine's own stock chart. Adjusting for splits, this stock first dropped its wares into the market above $600/share! The high on that first auspicious day was $710. Where is the stock now? You guessed it…a mere $3.15. Essentially, a complete (albeit slow) destruction of the very shareholder value the board seems so desperately interested in preserving now off the backs of their hapless employees.
The recession that came with the bursting bubble was not severe enough to cleanse re-assign all this poorly allocated capital. It sounds brutal, but when precious capital gets spent on unproductive activities, there is less capital available for activities that actually provide jobs and economic growth. Even Greenspan could not print enough money to create an economy of infinite resources. Until that happens, the sooner capital gets re-allocated from the unproductive to the strong, the sooner an economy can work for the good of greatest number of folks. Since Greenspan rushed liquidity (cheap money) into the collapsing bubble, worthless companies have been allowed to provide a drag on the recovery…for example, providing destructive pricing pressures and hiring labor that would have better been employed elsewhere. How much of a drag this has been, I sure do not know…but it sure has not helped. Of course, this very notion is controversial because Greenspan himself has argued that the alternative would have actually caused more pain. I agree with the critics…either take your pain in one big, ugly lump and get about the cure or bleed slowly but surely and pretend nothing is wrong the whole way down.
One mixed signal I find particularly vexing is that beer consumption now seems to have slowed! I can understand how small, niche beers like Boston Beer (maker of Samuel Adams) can run into troubles (they warned of a big shortfall on August 25, 2004). But Anheuser-Busch?!?! They had this to say last week: "'From mid-June through August, however, consumer demand for beer slowed, as it did for many other consumer product categories. Abnormally cool or wet weather in some key markets has played a part, and higher gas prices have also dampened sales.'" (Briefing.com). Supposedly, during recessions, beer consumption goes up or at least does not go down. But are we to believe that beer drinkers currently would rather let their cars guzzle gas than their bellies guzzle beer? Seems counter to the "drown your sorrows" theory! Nevertheless, if higher gas and other economic woes can make middle-America slow down beer-drinking, then we can only imagine what other "middle to low" market items can suffer. I would be very interested in understanding how luxury wining and dining is doing these days!
And now, to the charts and Dow Theory. I have made several references to this venerable theory over the past year or so. It has not been completely useful in forecasting the market's future moods, but I always find it to be a potentially interesting observation to add to the mix of other signals. Incredibly, as we are all getting used to the notion that the economy is slowing down, the transportation index has actually soared to new 52-week highs again. Talk about a mixed signal! This index is still below the all-time highs set in 1998 and then in 1999, but the current break-out sure makes it seem that a return visit to grandma's house is inevitable! See the chart below (courtesy of bigcharts.com)…
It is clear from this chart that while we spent the first half of the year interrupting the sharp bounce and uptrend from 2003, we now seem to be back on track. Contrast this with the Dow Jones Industrials chart seen below (courtesy of bigcharts.com again)…
You should immediately notice two things. First, the entire year of 2004 has represented a complete halt in the bounce and uptrend that started in 2003. In fact, the Dow Jones Industrials has slowly but surely trended downward all year. Second, if you look closely, you can see that this downtrend is consistent with a very slow and subtle downtrend that has been in place since the peak in early 2000. We are thus at a very important juncture according to Dow Theory. The break-out of the Transports needs to be confirmed by a similar break-out and new high of the Industrials. If the Industrials instead turn back downward to resume their downtrend, we will get a failed high in the Transports and a signal that the Transports current rally will soon fail. If the Dow does indeed break-out from here, I will be forced to "turn coats" and declare myself a bull…at least outside of technology stocks! Stay tuned…
Now, for a grand finale of sorts for mixed signals…some political commentary (imagine that?!). I am not one to believe polls because I find it hard to imagine that there truly exists a reliable statistical method to take a sample of less than 1500 American voters and question them in such a way that they end up representing the entire United States voting population within a few percentage points. Yet, that is what these polls claim -- let's play along just for the sake of argument: From the Latest AP-Ipsos Poll: "Since the Democratic National Convention ended in late July, the president has erased any gains Kerry had achieved while reshaping the political landscape in his favor: Nearly two-thirds of voters think protecting the country is more important than creating jobs, and Bush is favored over Kerry by a whopping 23 percentage points on who would keep the United States safe. Voters were slightly more likely to say a candidate's positions on issues is more important than leadership and personal qualities. Of those who cited issues, Kerry was favored by 10 percentage points. People making a gut-level choice overwhelming favored Bush, 65-29 percent. The AP-Ipsos survey of 1,286 registered voters, conducted Sept. 7-9, had a margin of error of 2.5 percentage points. The sample of 899 likely voters had a margin of error of 3.5 percentage points. " (The article was unclear on what sample was being referenced when…"Poll: Kerry Lags Bush on National Security" - AP, September 11, 2004). There used to be a time when it was "the economy stupid." Now it is "your very life stupid." (My grandmother always tells me this related joke…When Rockefeller faced a mugger who asked "Your money or your life!" He responded "Can I think about it?")
Kudos to the Bushies in getting Americans to fear for their lives more than they fear losing their jobs. After all, how can you report for work when you are dead…right? If we can extrapolate the sentiment of the electorate to market sentiment, we can get a better understanding of why economic and financial fundamentals have not consistently produced the results one might expect. The market is likely quite ambivalent about the numbers when it really fears that all its hard-earned gains could disappear in a mushroom cloud (not to mention Kerry tax hikes!). But I have also noted in several pieces how the market has proven remarkably inconsistent (truly resilient) in responding to various terrorist threats - both real and imagined. This ambivalence should continue until more certainty arrives on the election, and, if it is at all possible, a read on just how safe or unsafe we really are.
Those of you who know me probably recognize that I am even more intrigued by the implication from this poll that Bush voters are going with instinct and gut-feel while Kerry voters are making an intellectual choice. Since I have often derided the President for being a mental lightweight, no one should be surprised that I am not surprised by this implication. But what does this say about where America is right now? Can we go so far as to say that those who are concerned about issues are less concerned with terrorism? Can we go so far as to say that those who are afraid of terrorism are scared "out of their minds" to the exclusion of many other important concerns? We need to get serious about asking these kinds of questions. Many regimes from history have done awful things when their subjects were governed by fear. Democracy and freedom cannot thrive in an atmosphere of fear. Have we truly gone from FDR's admonition that 'the only thing we have to fear is fear itself' to a terrorist-driven era where 'the only thing we have to fear is that we are not scared enough'? So far, the financial markets are still far from being controlled by the fear of terrorism. If they were, the market should be a lot lower and the "fear index" represented by the VIX should be a lot higher. Perhaps these characteristics represent a market confident that there will be no regime change in this country in November. Perhaps the market is actually behind the curve. Perhaps the general populace is no longer participating actively in moving the markets --- that is, the petrified amongst us have already removed our money and have withdrawn to higher ground (for example, increasing investments in real estate).
These questions are hard to answer but the numerous paths of inquiry once again suggest to us that mixed signals abound. I guess we better get used to it…
Be careful out there!