MARKET OBSERVATIONS

BUY?  WITH WHAT? 

MARKET OBSERVATIONS - 5/2

Margin Notes...One thing that does seem to be different this time is that in the April (so far) correction, margin debt became an issue incredibly fast.  It wasted no time at all in becoming the life of the party.  By almost any measure, current margin debt is high.  The following chart is representative of the fact that debt supporting stock values today (or as a percentage of the market value of those stock holdings) is easily at it's highest level in almost the last half century plus.

What's quite interesting is that the above chart was produced before the little April "buying opportunity".  As you know, receding asset values will spike this chart, assuming margin debt is relatively unchanged.  It's the same deal for investor's personal balance sheets.  Asset deterioration set against the pale backdrop of unchanged liabilities.  Isn't this the description of the bursting of a financial bubble?

The anecdotal signs are right in front of us that the deleveraging process has already begun.  Julian Robertson is already finished with his professional process of deleveraging.  The Soros folks have begun and are probably most of the way through, if not done.  Many day traders have been carried out on margin stretchers over the past four weeks.  As we've discussed, mutual fund cash levels display the fact that forward liquidity is becoming more questionable.  It just may be that liquidity generated from margin debt has also already seen its best days.

As the overall value of the total market has trended higher and higher over the years, the liquidity heart has had to pump harder to keep up.  At some point, the rate of change of the rate of change kicks in as the value of the overall market begins weigh heavily on continued cash inflows.  In the first quarter of 2000, margin debt increased $50 billion.  Inflows to domestic equity mutual funds increased by roughly $93 billion.  (As can be surmised from the conceptual mentality characterized by the mutual fund cash reserves chart, this money was immediately put to work.)  In that same period of time, the value of all stocks on the NYSE declined by some $200 billion.  (This was before the April reality check.)  What is even worse is that in 1Q, almost $100 billion went specifically into aggressive growth and sector funds.  The short term experience of this money has been anything but reassuring.  Liquidity is meeting the very beginnings of fear and distribution.       

Let's see, Alan and friends increasing the interest rate burden in the real economy and legislators increasing fiscal spending simultaneously.  Attempting to fight inflation and acting to stoke it at the same time.  Go figure.  Reinforced by the little ECI surprise last week, interest rate futures are clearly predicting the continuation of monetary tightening ahead.  Unfortunately the Greenspan conundrum continues unabated.  Raising rates.  Rattling swords.  Talking tough.  Yet at the same time flooding the financial system with liquidity when either the stock market says boo or interest rate spreads widen noticeably.  Maybe Greenspan will learn, to stop a runaway economy and financial market, restricting overall liquidity is a key ingredient in the equation.  We say maybe he will learn as we have seen no noticeable signs of his realization of this as of yet.  In the meantime, the saga continues.  ECI, housing numbers, and the consumption component of GDP on fire.  The clear and present threat of a possible 50 basis point slap.  At the same time, Treasury debt buybacks, Fed monetary operations that provide liquidity (repo's, etc.), and increased fiscal spending.  Let's face it.  The simple question here is "where is the logic in all of this"?  What is the plan?  (There is a plan, isn't there?)

Reading Between The Lines...As you know, Tim keeps us all in check with super chart work and observations.  It is undeniable that significant damage has been done to the highly speculative end of the market.  Likewise, we are seeing former blue chip darlings being taken out and shot on almost a daily basis.  ATT, Microsoft, Procter & Gamble, you know the rest.  They simply are not coming back, for now.  Rotation is schizophrenic and haphazard.  Here's the latest for the almighty NDX 100:

Last, but certainly not least, the SPX:

If we go down and test the old lows, we would suspect that the market would encounter one of its most critical junctures in years.  It's the juncture of confidence, not necessarily price.  Clearly the public did not blink on the first go around on the downside.  There were no net redemptions in mutual funds.  If we are truly in a bear market, decisively breaking the old lows may just turn the tide of perception and confidence.  Certainly this remains a possibility as opposed to a certainty.

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