ContraryInvestor - Market Observations

MARKET OBSERVATIONS

MARKET OBSERVATIONS - 2/22

The Last Holdout?...We all know that the NASDAQ is the "market of the next century". Now that we're in the next century, will this continue to be as true as it has been recently (especially over the last year)? Maybe looking out over a decade or two, this dream will come true. We'll just have to wait and see what happens. Over the next few years, we have some serious doubts. We know, this type of thinking puts us in the minority within the minority.

Despite trying to allow the DOW to enter the "New Economy" by reshuffling the deck and playing the tech card (MSFT, HWP, and INTC), the DOW is approaching its October lows and stands basically where it was in mid-April of 1999. Currently being weighed down by profitable "old economy" stocks, performance is going nowhere fast.

The S&P is not doing a whole lot better. From the October 1999 lows, we're up about 9%, but looking back to mid-April of 1999, performance is a hair under 5%. In other words, the S&P has provided the equivalent of a riskless Treasury or money fund return in the last 10 months. Unlike its DOW counterpart, the S&P has much more exposure to tech. Cisco, Sun, Oracle, etc. grace the top 10-20 spots in the S&P Index and, quite frankly, throw a lot of weight around. What the S&P performance is clearly saying is that non-tech holdings are severely negatively effecting index performance to the down side. As you know, top S&P former (?) tech related darlings such as LU and WCOM have not helped the cause, to say nothing of consumer favorites and financials such as PG, Walmart, Citigroup, etc..

In what has to be one of the greatest divergences of a single major index relative to its big index counterparts on record, behold the NASDAQ:

With the NASDAQ, positive performance off of the October 1999 lows is still close to 70% and from mid-April of last year, it's approximately 85%. It truly is in another world. Luckily for the NASDAQ index, it's not weighed down by non-tech baggage (from a cap weighted perspective).

The divergent trend between the NASDAQ and the like performing S&P and Dow have been accentuated since year end. Let's look at a few facts. We now know that margin debt over the last three months increased an unprecedented $61.2 billion. For the same three month period, it's been estimated that close to $60 billion also came into domestic equity mutual funds. (As we have been chronicling, it has primarily gone into tech and Net funds.) So, here we have roughly $120 billion of new funds flowing into the market. From late November to late January, approximately $20 billion of new deals came to market, so net-net, roughly $100 billion was available for Dow/S&P/NASDAQ investments (of course there is crossover here). By the charts above, you know where the bulk of that money went - straight into NASDAQ issues. For some further perspective, from late October to late January, the NYSE composite fell from 625.5 to 621.7. Translated into dollars, this is a loss of approximately $145 billion. This isn't news to anyone, but the very few are prospering at the expense of the many. Imagine a net $100 billion of new money coming into the market and having the value of the much larger NYSE composite (compared to the NASDAQ) falling $145 billion over roughly the same period of time. This is not a pretty picture. It's a picture of broad distribution.

Champagne Wishes and Technology Dreams...Throughout history, perceptions on the part of investors of structural economic and financial change brought on by advances in real world technology and an accompanying acceleration in stock market speculation have always ended in like manner. Dreams deflated. Perceptions brought into line with economic reality. And expectations reset (usually around factual P&L and Balance Sheet certainty). The extreme divergence in the indices says we may be nearing or have arrived at one of these speculative conclusions. (The fact that the Fed has also partially closed the monetary floodgates also supports this possibility.) We believe Barton Biggs of Morgan Stanley described this extreme in market characteristics quite elegantly in one of his recent pieces as he opined, "New Economy stocks are being priced as if there's no risk, while Old Economy stocks are being priced as if there's no opportunity".

Of course today's investment cognoscenti describe anyone skeptical of the "new economy", the new metrics, the new era, modern day corporate "traction", as idiots. The skeptics "just don't get it". It's just a shame that some legendary veterans of the technology venture capital game are also quite skeptical of the capital and stock market attention being thrown at many NASDAQ darlings. Silicon Valley's own Don Valentine (remember folks, he was there when there were still orchards from stretching Menlo Park to San Jose) says that "we have nearly 10,000 Internet companies too many. There is an Armageddon that's going to happen in the spring, after all those companies spend their huge advertising budgets in the fourth quarter (seeking brand recognition and identification) only to fail and come out the other side broke." In a recent article, Forbes counted 1500 e-shoe companies, 50 major beauty sites, 400 auction sites, and thousands of vitamin and drug sites. Does the word "redundant" ring a bell?

Crude Coincidence?...Last week we mentioned the fact that U.S. politicians were jawboning OPEC to raise production (help the price of oil decline). As you know, OPEC has shown some new-found cohesiveness over the past few years that has allowed crude prices to ascend to almost ten year highs. Could it be that the Saudi's/OPEC are just bears on the U.S. financial markets? Sound far fetched?

Think about this. As you know, the price of crude on global markets is dictated in terms of U.S. dollars. As goes the dollar, so go relative OPEC profits. Is the recent ascendance of crude prices nothing more than an OPEC bet that the dollar will fall relative to foreign currencies ahead? Clearly it's not totally this, but we have the feeling it's a partial rationale. We've reported to you time and again the Fed shenanigans regarding credit and money creation over the past year or so. It's simply public information. It's on the Fed web site and is published weekly in Barron's. Surely the folks at OPEC see the numbers. They also have the following monthly report card:

Is OPEC keeping the price of oil high partially as a bet that the US dollar is in for rough sledding ahead? The imbalances existing in the U.S. financial market and economy aren't exactly a secret. In fact far from it. The Economist regularly comments on trouble they believe is clear and present. As you may know, OPEC has already publicly announced that no increase in production supply will be agreed to at the March OPEC meeting.

Let's take a brief look back. Here's a chart of the U.S. trade-weighted dollar over the last two and one half decades:

Again, maybe it's coincidence, but oil prices rose from 1973 until they peaked near the 1980 period. You remember 1980 - oil going to $100 per barrel. Energy stocks at 30% of the S&P (as opposed to today's bloated technology favorites). During the following half decade, the price of oil traded up and down, ultimately hitting almost a panic low mid-decade, all the while the dollar was strengthening. The low in oil was seen coincidentally just as the dollar peaked and was set to recede relative to foreign currencies in the mid 1980's. After hitting a mid 1980's low of close to $10 per barrel, west Texas intermediate crude prices traded in a band between $15-22.5 per barrel for close to ten years, ending in late 1998 - just as the U.S. dollar was again peaking on a trade-weighted basis.

We're not making the argument here that OPEC has become currency speculators, we're just saying that we believe that are trying to control the price of oil with a much broader vision of global economics and finance than may be apparent to the average investor. As you know, the consensus believes that the price of crude is simply not sustainable near and above $30 per barrel. In like manner, the consensus believes that the trade deficit is not a problem, we're in a "new era" for stocks, money and credit creation alarmists are laughably fanatical, and that we are in a golden age of technologically driven prosperity. It just may be that OPEC is taking the other side of the perceptual trade and protecting its price now. Ahead of a possible dollar deluge. Once the global U.S. dollar recycling program (foreigners investing trade deficit dollars back into U.S. financial assets) comes to an (abrupt?) end, the dollar will surely be a question mark at best.

Just Like The Good Old Days...It's been some time since we've had a good old fashioned ramp job in the S&P's like we had today. A 2% move straight up in about 45 minutes time seemed like deja vu all over again. Just when the S&P looked like it was ready to breach its lows of the day, "profit taking" abruptly came to a screeching halt and the sophisticated dip buying began, in earnest. What a shame that both NASDAQ and NYSE breadth was so rotten. It seems like every time "they" throw a party, the guest list just gets smaller and smaller.

Red Sky At Morning...Sailors warning? Our prescient charting friend Tim has been kind enough to provide you/us with his simply impeccable work. For those who have been following his work each week, well, you already know. For those who haven't, maybe it's time to listen up. Here's the latest:

Unless "certain someone's" plan more S&P ramp-o-rama's, Tim's long standing target is drawing closer by the day. Simply picture perfect declining lows and highs. Classic. Right out of the textbook.