Worthless Dollars Are Flushing Out the Bulls

By Dr. Duru written for One-Twenty

November 11, 2007


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There are so many equally appropriate titles swishing in my head for this missive.

"Fed Fade Finally Complete": After the Fed first cut rates on September, I predicted that "...we still have some conditions in place for what I anticipate should be the fade of the year. I cannot see the market giving up the biggest pop in 5(?) years in one day, but I have a strong suspicion that we will see prices return to Tuesday's open before we get new 52-week (and all-time) highs in the market." Well, ok, I was slightly off. The S&P 500 soared to make marginal new all-time highs before the Fed cut a second time. But the market faded that pop the very next day and within one more week the market faded September's monster pop.

"Diverging Markets Reconvene to the Downside": As I waited and waited for that Fed fade to happen, I took note on several occassions that one sector after another faded the Fed relatively quickly. Morgan Stanley began the fades after reporting earnings on September 19. For the next 4 days, and then the following month, I ticked off homebuilders, retailers, financials, and transports after each sector gave up the September post-Fed gains. By October 17, the divergence in post-Fed performance was fully entrenched, showing that the Fed had not provided any short-term relief to the very sectors that had compelled the rate cuts in the first place. The S&P 500 had just come off all-time highs and the NASDAQ was still on its way to making yet another 6-year high. It seemed that the general market was willing and able to leave the recessionary sectors of the economy further and further behind to toil in the dust. My Fed fade expectations seemed only partially fulfilled, and I readily held out a prediction of a strong close to the year. I remained undeterred when even the semiconductors finally broke off into the camp of the downtrodden. The major indices followed suit downward shortly thereafter.

In September, I stated that I expected the brokers to lead the market, like a canary in a coal mine. However, the brokers scattered every which way with Goldman Sachs (GS) charging to new all-time highs, Lehman Brothers (LEH) chopping along to nowhere, and Merrill (MER), Bear Stearns (BSC), and Morgan Stanley (MS) taking steep dives one after the other. In other words, the market's divergence has itself been a diversion - allowing both the bears and the bulls to remain hopeful. The bears finally won out in convincing style. There was no better way to end the party than the three-day collapse in the shares of Cisco (CSCO). The stock soared to new 6-year highs ahead of way too much hype and anticipation for its earnings. By Friday CSCO completed a 16% swift kick from those highs all the way back to the 200DMA. On the earnings conference call, CSCO alarmed the market by stating that it saw a "dramatic drop in orders from financial services and auto." Instead of being the crown jewel of the "hide in tech, sell financials" trade, CSCO became a beacon of panic. Suddenly, a breach opened in the teflon wall separating the recessionary sectors of the economy from the go-go, growth sectors. Growth stocks everywhere shuddered and stalwarts like GOOG, BIDU, and RIMM took it on the chin. Fear often causes folks to shoot first and ask questions later: not only did momemntum IT favorites like VMW lose 15% in 2 days, but even reliable Oracle lost 12% and stodgy IBM got pounded for a two-day 9.5% loss. (You have to see these charts for yourself!) We have now hopped from one frying pan to the next these past 2 years: housing bubble pop to credit crunch to banking crisis to looming retrenchment in technology spending (again).

The Fed tried to "shock and awe" with a 50 basis point cut in September, but it did nothing but provide temporary relief to the market's headache. It was a psychological boost with no apparent substance; it mollified fear without removing the scary. The brain tumor is as bad as ever and perhaps getting worse. The Fed rate cuts greased the skids of worthlessness for the dollar and have ironically contributed further to the problems (what else is new, eh?). So, I chose "worthless" for my title and theme of this missive.

The markets cried and cried and whined and whined until the Fed finally gave in and delivered a monster rate cut in September. But that was not enough and another episode of market concern for credit problems forced the Fed to capitulate again for a "bonus" rate cut last week. However, you can tell the Fed's patience has started to wear thin with these antics since it slapped the obligatory inflation warning back into its statement explaining the rate cut. This action all but crushed the hopes of the credit addicts for further cuts (let's see what new methods they use for turning up the heat on the Fed). In many ways, the damage has already been done. These rate cuts have confirmed the worthlessness of the dollar. No amount of chest-thumping and jaw boning about inflation risks can disguise the teetering pyramid of funny money that America sits on. We have spun the printing presses well past midnight not only to fund all manner of government and consumer spending and tax cuts, but also to generate loans to all who have asked. We all know the story now of how easy money first fueled the tech bubble and then the housing bubble. Each bubble made us feel much more wealthy than we really were, but the housing bubble hurt the most because average folks were able to cash in big and not just executives and lucky employees #1 to #25.

The contagion of easy money has reached far and wide. For example, the easy money went into repackaged loans in the form of various securitizations that combined the junk loans with the good and sold them as "low-risk" instruments to unsuspecting investors across the world who believed the models. The funny money allowed the private equity squads to afford to pay ever-higher prices for ever worsening companies. Oil has now gone nearly straight up for 3 months largely because of the dollar's continued decline (oil is priced in dollars...for now). Banks are the big warehouses for this currency. So, is it any surprise that banking and brokerage stocks continue to slide? Their primary product is losing value at an alarming rate and, even worse, more and more people are losing faith in the various ways in which this paper is dressed up for distribution and re-sale. Even the Chinese are getting more vocal. China has already made threats to go nuclear with dollar sales in retaliation for any U.S. trade sanctions. The market decided to take these threats more seriously last week when an anonymous senior Chinese economist indicated that China is now indeed ready to shift some of its incredible $800 billion in dollar reserves into more worthy currencies. Given how long the Chinese have held onto this declining "asset," I am inclined to wonder whether Chinese dollar-selling might finally put in a BOTTOM for our worthless currency in classic buy high, sell low fashion. Regardless, the cascading effects of worthless paper are reaching far and wide. Instead of simply providing a refuge for American companies with global reach, the worthless dollar is flushing bulls right out of the game.

I will end with some fodder for conspiracy theorists. Let's recall that our Treasury Secretary was the Chairman and Chief Executive Officer of Goldman Sachs and had a storied career there for 32 years. Goldman Sachs was the only major brokerage to recover from August's swoon to hit all-time highs. Our President was a former oil man, and oil is effectively at record highs a year before his Presidency comes to a crashing end. Hmmm....do you think our Treasury will just sit back and let our banks and brokers crumble into dust? It's not just bad for the economy, it's bad for the friends of the government! Do you think that the White House (and Republicans in particular) will just sit back and let the economy crumble and reduce America's ability to afford ever higher oil prices? It's not just bad for the economy, it's bad for the 2008 elections and bad for the oil business...and bad for the friends of the (former) ruling party! I only mention these to remind us that even as darkness appears to descend on the bullish thesis, you have to keep in mind what MIGHT go RIGHT. For example, somehow, we might manage to postpone the day of debt reckoning yet one more time. We have bounced twice already this year from rampant credit fears, and if the August lows hold, you have to prepare for another bull run - even if relatively short-lived. The market has chosen to ignore the on-going credit crisis longer than it has chosen to care about it. To this end, I am still expecting a strong finish to the year, just from lower levels than I first thought. Yes, I know that provides little comfort after the market has suffered such serious technical damage. 2008 will be a whole new ball game, and I am definitely not hazarding a guess (yet) as to what fun awaits us around THAT corner.

Finally, here are two links I have found very interesting lately. They seem particularly appropriate as the bears run wild:
PBS posted a special feature on the crash of 1987 by including the broadbcast from the Nightly Business Report that day. And Jon Markman, a man who is usually pretty good at spotting very bullish stories, suddenly seems a whole lot more bearish. Check out his list of 25 stocks to avoid now.

Be careful out there!

DR. DURU®, 2007