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Posted 5/17/2004
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We are not going to see new highs in stocks
The stock market looks increasingly hostile right now. Too many people are overconfident, theres too much speculation, and the Fed has no maneuvering room.
By Bill Fleckenstein
Folks had gotten mighty lathered up for Cisco Systems' (CSCO, news, msgs) earnings, which came out after last Tuesdays close. In a testament to speculative fervor, slightly out-of-the-money $22.50 calls were running about 5 to 1, vs. slightly in-the-money $22.50 puts. But habitual arm-waving by its CEO, John Chambers, packed no punch. On Wednesday, the stock closed down better than 1% and was down again on Thursday.
The innards behind the arm-waving weren't all that spectacular. In fact, inventory grew 20% quarter-on-quarter, and the inventory was up about 47% year-on-year (pushing inventory days, quarter-on-quarter, from 49 to 58). Of course, Cisco said it needed the inventory due to longer lead times. To me, however, that buttresses the point about the double and triple ordering that's been occurring for some time now.
We already knew that Intel (INTC, news, msgs) and Texas Instruments (TXN, news, msgs) have shown larger inventories, as has virtually every contract manufacturer. Now we can add Cisco to that list. For the past six months, I have talked about the inventory buildup, waiting for signs of a slowdown in end-market demand. While that hasn't been seen thus far, except maybe in Nokia (NOK, news, msgs), inventory has built to a point where disappointments are going to happen even if end demand doesn't slow. (And I expect it will slow.)
Hear Biggs crow, see stocks go
Cisco did not have a whole lot of company in the negative column last Wednesday. The market executed quite a turnaround that day, in which many of the heretofore losing indices emerged as winners. Kudos were apparently in order for market strategist Barton Biggs, who spouted on Bubblevision that we would have a huge rally. How fitting, given that the stock market has become a giant commodity, and 8,000 funds are now competing as day traders looking at pictures and moving averages.
On the eve of Cisco's earnings, I opined to readers of my daily column that Wednesday would be very important, as I anticipated precisely the kind of report that would be a litmus test for the market. Would the bulls be able to sustain the stabilization/rally attempt that had begun a couple days earlier? Would they be able to produce a big bounce? Or would weakness reassert itself?
Beware a beguiling bull
Wednesday, in fact, brought both. Initially, the action was ominous, particularly with the market averages already negative for the year despite pretty decent company-specific news, and despite having received a wall of money. The latter reflects folks' overconfident assumption that an election year has to yield positive returns.
On the other hand, just as it looked like the dam would burst that day, the market bounced. Perhaps the bulls will attempt to build on that bounce, fueling the rally for a little while. But I feel very confident in saying that we are not going to new highs. Whatever rally we have in the wake of last week's turnaround will fail.
Much of what's happened in the last year to the economy, the stock market and macro-management by the government and its various entities has been unhealthy. For too long, folks have believed that good times are right around the corner. What they have not understood is that the sunnier interlude over the last year stemmed from the Fed's getting the American public to use housing as an ATM. The latter, in combination with the government tax cuts, have "underwritten" the speculation that has delayed the adjustments from the previous stock mania.
The fact that the Fed is trapped -- unable to ease to "save the day," pressed to tighten to stave off inflation and likely to tighten too slowly -- appears not to have dawned on folks yet. When reality sets in is anyone's guess, whether tomorrow or any number of weeks from now. All we can do is be alert to a change in psychology. But when this inflection point arrives, we will battle not just the adjustments from the previous stock mania but also the current real-estate bubble.
Sometime soon, I expect that prices will once again begin moving to the downside on a regular basis. And, at some point, we are going to see a massive dislocation or crash-like event. The stock market, prospectively, looks like an extraordinarily hostile place to be. Folks should proceed with maximum caution. Regrettably, the accident that's been building and is waiting to unfold will be unbelievably brutal, in my opinion. The only safe place will be short-dated government paper, combined with foreign currencies or precious metals.
Metal shorts as engines to the upside
Meanwhile, the precious metals have endured a brutality of their own, vis--vis a recent decline of some 30% in the price of silver. Though it's not possible to know where the bottom lies, my contacts in the dealer market say there has now been a good deal of short-selling by funds in precious metals.
I am fairly confident in making the statement that these metal shorts will only add fuel to the fire on the way back up, once these markets turn. As a friend and professional precious-metals trader told me last week: "Written in stone, those selling today will lose money. The only question is how long it takes."
Whatever happened to the ETF for gold?
Lastly, this is for anyone eager for and curious as to the mysterious whereabouts of that exchange-traded fund for gold. The fund was to have launched around January. If youre interested, I invite you to join me and Market Rap readers in a campaign called "Free the ETF." After checking around a bit, I think that perhaps the most constructive thing folks can do is convey their sentiments via letters to the commissioners of the Securities and Exchange Commission. It might be something along the lines of:"I would like to trade gold, via an ETF, as soon as possible. With nearly 100 ETFs now trading on a variety of instruments, surely the SEC could allow gold among those offerings. And yet, the most recent S1A for the gold ETF was submitted almost six months ago. What's the holdup?" The letters should be sent to SEC Commissioners William Donaldson, Cynthia Glassman, Harvey Goldschmid, Paul Atkins, and Roel Campos. The address: SEC Headquarters, 450 Fifth St., N.W., Washington, DC 20549. I have no idea if this effort will bear fruit. I don't see any downside, however, and, at a minimum, we might learn the source of the delay.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment 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. At the time of publication, he was short Cisco Systems, Intel and Texas Instruments. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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