ContraryInvestor - Market Observations

MARKET OBSERVATIONS

CYBER NUTS

MARKET OBSERVATIONS - 3/21

Swimming In Dangerous Waters...The trade/current account deficit reported last week was yet another sight to behold. You know the chart by heart:

Forget the fact that we are in need of a $1 billion per day loan from our friends on foreign shores. As you know, today's trade deficit was another record showing. New high on the S&P, new high on the trade deficit, new high in margin debt, new high in consumer debt, new high in financial sector debt, etc. What's next, a new high on the Dow and the NASDAQ? (Don't be surprised.) Investors would do well to remember that whenever the current account deficit has exceeded 3% of GDP in this country, the dollar has been in for a rough ride. A ride in a southern direction. The current account deficit as a percentage of GDP came in a (4.2%) for 4Q. Look out ahead?

It's a bit telling that despite a 125 basis point increase in short rates over the last year, the trade weighted dollar has basically laid flat. It's Y/Y rate of change relative to foreign currencies on a trade weighted basis is close to zip. God forbid that dollar assets such as NASDAQ stocks were ever sold in earnest. Imagine.

The Next Shoe?...Greenspan has tried to talk this market down, albeit mostly sheepishly. Five rate increases later and the party in the big cap indices can only be toned down for brief interludes before renewed panic buying. Not only the Fed, but also their global central banking brethren have remained far too accommodative for far too long. Raising interest rates in 1/4 point increments in the US, the UK, Australia, the ECB, etc. just isn't doing the trick and won't do the trick in the future. Money/credit is being created outside of the Fed's control in the US as a natural response to demand, in spite of Greenspan. We heard over the weekend from an institutional friend of ours that collateral requirements are being raised by brokers for derivatives transactions. Is this the next shoe? Of course Greenspan may not come out and publicly acknowledge a change in margin policy, but a behind the scenes coercion would seem most appropriate at the present time. What better a way to chip away at the linkage between the commercial lending and brokerage industries. Greenspan certainly does not want to destroy equity values (as he so amply demonstrated today), he just needs to stop wanton speculation as a first course of action. If this is true, the Fed sword should be pointed at the hedge funds, the proprietary trading desks (brokers, commercial banks, etc.) and other margined players. The exact crowd most likely responsible for some of the dramatic moves we are witnessing in individual securities and the indices themselves. Want to take a guess as to what these players own?

CYBER NUTS?...Anecdotes of the mania are plentiful these days. We have refrained from telling our fair share of stories, but this one is a special example of "blind faith". An acquaintance of ours has owned a company called Xybernaut for a few weeks. When he originally told us of his investment, he only knew the stock symbol and hadn't a clue as to what the company did for a living. Of course it was a tip. XYBR is a BB stock that has risen from the low single digits to the low $20's over the last six months, after a brief rest stop in the high $20's. Last Friday, a story crossed Bloomberg about 1 hour prior to the close stating that the company's new auditors, Grant Thornton, had issued a "warning of substantial doubt about the wearable computer maker's ability to continue as a going concern because of continuing losses and a need for more capital". The company's prior auditors, PriceWaterhouseCoopers, were fired last Sept 13. PWC had also rendered a "going concern" warning. Management was quick to rebut the Bloomberg article stating it was comfortable with the company's financial position and that auditor notes regarding going concern doubt had been in its financial statements each quarter since originally going public. How reassuring.

What may be more interesting is that in the Bloomberg article, notes from Xybernaut's annual report revealed that the company had been selling unregistered stock in January and February of this year well below the market price of the trading stock. Unregistered stock was sold in January by the company for $3.80 per share. In the open market, the low trade for the month was $5 9/16 and the weighted average price for the month was $11.20. The company borrowed $3 million in January at 10% and issued the lender warrants to purchase shares at 10 cents as an inducement. Nothing here is illegal and, in fact, none of these actions are uncommon in the new world. The stock was hit for a loss of almost $5 1/2 last Friday, but quickly recouped the entire drop as of today's close. (After all, they'll be on CNBC's "The Edge" program tonight.) We really do not know Xybernaut and do not pass judgment on the company's investment merits. This is just an anecdote of the faith investors are putting in as of yet unproven companies without profits. As you would imagine XYBR took top honors in the last few days on chat boards such as Raging Bull and the Yahoo posting boards. Maybe we are simply comparing apples to oranges, but can you imagine if P&G's auditors issued a going concern warning and you found out that they were selling unregistered stock well below market price? Then again, maybe P&G would have just washed out their auditor's mouths with soap.

The Greed Machine...The Fed's quarter point rate increase today was a peashooter trying to stop an elephant herd. The most revered Fed chairman in US financial history is a patsy. Not only isn't there any teeth, there's not even a bark left anymore. The boy who cried wolf is simply being ignored. How many more quarter point rate increases will it take to stop the greatest financial asset inflation ever experienced in US history? Too many more is the answer. And even then, it's clearly no longer rate increases that are going to stop this. We're well beyond that point. There is simply no constituency for addressing the financial asset inflation problem among the current government administration or the popular media (that does such a superb job egging on the public). As a symbol of capitalism in this country, Jack Welsh should clearly be ashamed of himself for what is allowed on CNBC. But, after all, it's all about money anyway. Who cares if the credibility in the capital creation mechanism in this country is destroyed for a few generations? Clearly not Jack Welsh's already wealthy and unborn great, great grandchildren. For the Fed and the Clinton administration to stand by and allow our very financial system to be put at risk is simply unconscionable. But, then again, when has anything except sound bites and polls counted over the last eight years? Answer: Never. Sorry for the soapbox antics. For all of our venting, we truly do care that what lies ahead will broadly hurt the American public. More than they could ever imagine at the moment.

The Long Run...Tim allows us to step back for a moment and look at the much bigger picture:

Try to keep what Tim has presented in the back of your mind. The day-to-day volatility can be frustrating and wearing on the emotions (and the pocketbook for that matter). The SPX appears to have set up the channel of all channels in the last five years. The traders of the moment are completely wrapped up in the MACD, the 200 day, the 60 day, the 5th wave, the head and shoulders, the failed flag, you name it. Simply put, once this long term channel is decisively broken, we're going to be in the financial repair shop for a good while.