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Posted 11/25/2002
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It's just another rally, not a fresh start
Ignore the blather about how the stock market has hit bottom. The current uptick in stocks is nothing more than a huge bear-market rally. Unfortunately, theres still plenty of trouble ahead.
By Bill Fleckenstein
If dead fish, aka sell-side analysts, doubled as graffiti artists, you might actually catch a few of them spray-painting the word "sell." Just recently, the one-time unmentionable rating was plastered on an overpriced tech stock that deserved it long ago. Meanwhile, as valuation and fundamentals start to matter to the analyst community, "buy" (anything, at any price) remains the watchword of the other-people's-money crowd. Hey, there's a rally going, so don't confuse us with the facts.
In what might be the start of a trend in the dead-fish community, one of its members from a major wire house announced that he thought Intel (INTC, news, msgs) ought to be sold. I am reasonably certain that during the stock's entire descent from $70 to here, the s word has never been uttered at any large brokerage firm. A handful of times, we have heard, "Dont buy Intel, but never sell it." Whats noteworthy about the rationale is that this particular dead fish moved up the consonant chain to learn something about the v word, that being valuation. He noticed that it may not make much sense to pay this big price of 40 or 50 times earnings for a company whose business isnt really growing.
Feeling the earth move beneath the Street
So, I think we might ask ourselves, are we on the cusp of change? Have enough dead fish been fired by Wall Street that those who remain could conceivably start doing their jobs, trying to ferret out what makes for reasonable purchases and what makes for sales? If thats the case, theyll have to begin focusing on the businesses and the price of those businesses. And that, ladies and gentlemen, is what is meant by fundamentals.
For about six years now, I have been complaining that these analysts have not been paying attention to fundamentals. I have frequently ranted about the high prices that people have been willing to pay for technology companies with poor prospects. That said, there may be some interesting smaller-cap companies off the beaten path that are really quite cheap. But in the aggregate, the big stocks that the OPM crowd plays with are really just a variation of the greater fool theory. In any case, if the people who call themselves analysts are about to start focusing on fundamentals, I say better late than never. I would only add that if more of them keep this in mind as they begin each workday, theres only one place for most tech stocks to go, and that is down.
The old-geezer grind
Meanwhile, as the current rally sees them bid up by the OPM crowd, which is very busy handicapping "the bottom," I'd now like to attempt to put it all into perspective for readers. As to the question of whether this is just another rally or the low of the bear market and the start of a new bull market, let me say that even if the market does manage to work higher, there is virtually no chance we are seeing the latter. I believe that this is simply another rally.
Consider that almost all the biggest-percentage gains in history have occurred since the market peaked in March 2000. Think back to a year ago, when people were convinced that the lows had been made. We had a rather vigorous rally that ran from September 2001 to about January 2002. At the time, writing in my daily column, I correctly anticipated the rally, described it as just a rally, and said that we would make new lows when it was over. (At the time, mine was a distinctly minority view.)
Though I did not anticipate the current rally, what counts here is that there is no good reason to expect that it is anything but another upside flurry in an ongoing bear market. What these bear-market rallies succeed in doing is in getting people to take their eye off the ball and cause them to hope that things will improve, rather than deal with the issues at hand. I suspect that by now those who have tried to trade the rallies since the March 2000 peak wish they had not.
Hope for the bottom fogs spyglass
To appreciate the pitfalls of accurately predicting a bottom, take the case of Japan, where the bear market has been going on for 12 years. Initially, 20,000 on the Nikkei ($JP:NI225) was deemed to be the bottom. A couple of years later, people were declaring a Nikkei bottom at 15,000, then 13,000, then 10,000, and now here we are at just above 8,000. The point is, every time the market stops going down, people start declaring that the bottom has been seen. But just because the market stops going down and starts up doesn't mean that the bear market has ended.
I would also point out that most of the people who are bullish and who have called the bottom are the same people who did not see the mania for what it was and didn't understand what its unwinding meant. They continue to suggest that at any moment, it will be business as usual. And as if to hasten this, they resort to the same arm-waving analysis that worked so well in the mania, grasping for such spurious concepts as seasonal trends, presidential election cycles, how far down something is, etc.
Ladies and gentlemen, all that "analysis" is not going to end this bear market. What will end this bear market is the return of reasonable valuations and people having properly discounted the troubles that exist. Its demise will be ushered in by exhaustion (and real fear), not by people sitting around trying to spy the bottom. I would just add that to the best of my knowledge, those few people who did understand the mania, who talked about it while it was in force, and who described what its aftermath would be like have yet to flip around and suggest that the worst has been seen.
The refinance boomerang
Speaking of the aftermath, I'd like to spend a minute looking at how it is playing out across America. One consequence, for example, has been a misallocation in real estate and consumer debt that has serious implications going forward. People like to talk about how the consumer has helped to support the economy by taking on more debt. Largely, the refinance boom has been responsible for that. A reader of my daily column on RealMoney, who interpreted the data differently than Wall Street, e-mailed some statistics and comments that I agree with and wanted to share with everyone:
He wrote: "I subscribe to Economy.com, and right on the main page is a chart of cash-out refis, 1990 to the present. It will blow your mind that we may hit $300 billion this year. From 1990 to 1999, refis ranged from $25 billion to $50 billion a year. Look at 2000, with slightly over $100 billion; and 2001, with $150 billion. Add the last three years together. The total will hit at least $550 billion, just blowing away the combined total of the entire 1990s. What a mess we face in the future."
He continued: "This completely explains the consumer-spending binge that has held our economy up. What in the world is going to happen when debt-strapped consumers have to retrench for years to get their debt levels back in range? Find a good mattress, because what worked for our grandparents will work for us. We misallocated a ton of money in telecom, and the mess from that is still being cleaned up. Now we have misallocation in real estate and consumer debt, and we will see a decade ahead of trouble."
Mosquito statement
Then, there is the potential problem of underfunding at our nation's pension plans. During the mania, managers poured too much into stocks, and now the funds face serious losses. For instance, the Oregon Employees Retirement System recently announced that it has incurred about a $9.7 billion liability, and New Jerseys system said it lost more than $6 billion in its last quarter. My suspicion is that they are far from alone in their losses. To help shore up the funds of all these states, capital will need to be redirected there from somewhere else.
But the state tax coffers don't look like a good source. Recently, the Liscio Report, the well-regarded newsletter that tracks economic trends, noted that the tax receipts of many state and local municipalities are rather subpar. (Of course, if the overcapacity spawned by the bubble has led to your redundancy as an employee, you can no longer contribute any payroll tax.) I note a related wrinkle from the state of Colorado, which, in an attempt to make its current budget appear better, moved back a payday by one day. That will save it $268 million. In any case, if one puts a summation sign under all of this, a lot of these government agencies may be about to encounter some severe financial difficulties. Regrettably, I think we can expect to hear bad news playing out from this sector for some time.
Of omniscience and airbags
Stepping aside from the aftermath for a minute, I would just like to state that everyone is wrong sometimes. No one is right all the time, or close to all the time. No one. I have made tons of mistakes in my career, and will continue to make lots of them. Even someone as brilliant as Warren Buffett does not always get it right. In the investment business, the trick is to try to engineer yourself into a position such that when you are wrong, you don't get hurt badly. (Parenthetically, I would just add that people at home should never completely rely on any one person's opinion. They should absorb the opinions of people whose thought processes they like and make decisions for themselves. That way, they'll always know why they've done what they've done, and won't just have mimicked someone else's behavior, which will make it harder for them to make difficult decisions.)
This is why, when I operate on the long side, I choose the value approach, where I can build in a margin of safety to protect me against my errors. It is also why I advocate that people at home not try to sell stocks short, in which building in a margin of safety becomes very difficult to accomplish. During these periodic rallies, you have to do a lot of trading and use lots of different tactics to avoid getting killed. It's especially dangerous in the present environment, with 5,000 hedge funds and 5,000 mutual funds all behaving like children as they react to the last price on the board, making sure they aren't left behind during the rally.
Feathering the nest with fundamentals
In any case, for those who can't say no to the lure of casino action and play every rally in the bear market, all I can say is, good luck. But for most people, the thing to do is to continue to wait for an opportunity down the road when the risks have been reduced and the rewards are much higher. Few people at home have the time or the skills to trade successfully. Instead of getting sidetracked by how many rallies we have, they should be focusing on what matters. And what matters is whether enough values have been created and enough adjustments made so that the bear market can end and a new bull market can begin. I don't think we've seen that point yet. As I have been saying, participating in the market right now is, for the most part, just a game of three-card monte.
Finally, for those readers who would like to learn more about how to "stack the deck" in their favor when it comes to trading, I'd like to recommend a new site called minyanville.com (see link at left under "Related Sites."). It's extremely educational and written in an extraordinarily clever style by Todd Harrison. So, anyone who wants to learn more about the discipline and thought behind trading should go there.
William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At time of publication, William Fleckenstein held a short position in Intel. Positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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