8/24

A Typical City Involved In A Typical Daydream...We're Baaaaack (and ready to click ass).  A long strange trip it was not.  We were truly blessed to have had the ability to spend the last month in Europe.  Primarily Italy and the UK.  1% business and 99% monkey business.  After all, can you blame us for having to unload our strong US dollars before...well, you know.  Traveling throughout Europe does nothing but reinforce our strong conviction that change is a guarantee in this world.  The past mixes with the present as the lessons of history are laid out at one's feet.  Historical change in locus of financial and economic power, change in social and cultural systems, etc. is choreographed in the art and architecture of the continent and the UK.  We can't help but relate what the kaleidoscope of history has to teach relative to the current financial market environment in the US.  Although financial, economic and cultural change often took centuries to effect as Europe evolved in the first and second millennia, change in the current global economy has been digitized for high bandwidth throughput.  The only constant we can find in what is the guarantee of a changing world around us is human nature itself.  

As you know, we expect a tremendous amount of change in the US financial landscape over the next few years.  The excesses created in the last decade (primarily during Greenspan's monetary expansionist reign as Fed kahuna) will ultimately meet with reconciliation and reformation.  How many Venetian merchants 600 years ago would have guessed that Venice would ultimately become economically dependent on tourism as opposed dominating global trade and commerce?  Few at the height of Venetian economic power.  Could any Roman citizen living during the peak of the Roman empire credibly believe that the empire would ultimately collapse?  What member of the English royal family in power at the time of the Mayflower crossing would have believed that the small emigrant ship that set sail from a London port on the Thames would ultimately spawn a nation that would far surpass England in economic and military might?  It often seems that just when the unimaginable is about to happen, no one is using their imagination.  How many of today's indestructible individual investors believe that cash could outperform equities?  Perhaps for a series of years?  Not many.  Imagine that.  

It's The Stock Market, Stupid...The political machines on both sides of the table are acutely attuned to the importance of the stock market in the upcoming election.  We're most certain the focus is and will continue to be intense.  It may have been about jobs and the real economy in 1992 and 1996, but in 2000 it's the stock market that's important in the upcoming electoral spin cycle.  Every three years the Federal Reserve publishes a Consumer Finance report that details levels of stock ownership across various household income levels.  The last report was done for the year ended 1998.  Even though the data is a bit dated at this point, the message to politicians is unmistakable:

Across every wealth demographic measured, ownership of common stocks has increased since the last election.  Remember, this is 1989 data.  Most assuredly these levels are higher today.  After all, what flag waving American citizen could resist a five month doubling in the NASDAQ (completed in March of this year)?  Margin debt numbers and mutual fund inflow numbers clearly bear out the assumption that it's a great bet that household ownership of stocks has increased, perhaps substantially, since 1998.

As we said before our brief departure, we had expected all news to be good news heading into the election.  So far so good.  In the headlines during late July and all of August, productivity above 5% further substantiated the validity of the new era when viewed in conjunction with strong second quarter GDP.  CPI and PPI numbers were perceived as tame.  Once again, despite the reality of soaring home prices, energy prices at near decade highs, rising labor costs and geographic labor shortages, health care cost increases, and the beginnings of attempts at corporate commodity price increase pass throughs, new era math provided us with the headlines of continued low inflation.  At the Democratic national convention (begun with a blistering one day rise in the NASDAQ, Dow and S&P, of course) Clinton basically summed it up in his opening speech.  "Do you want this to continue?"  Just what do you think he was referring to?  Our bet is clearly the new "stoconomy".    

Lastly, the Fed is no stranger to the importance and meaning of the message in the above charts.  Well out of reach of the headlines, injections of liquidity into the greater financial system since we last had the pleasure to publish have been simply enormous vis-à-vis the coupon pass and repo mechanisms.  Couple these with the Treasury bond buybacks and there is more than enough liquidity to go around.  Indeed, the very heart of the problem.  Was it really any surprise at all that the Fed passed on a rate increase on Tuesday?  Of course it wasn't.  It's now a dash to the election finish line as all Greenspan hurdles have been passed. 

What A Long Strange Trip It Has Been...We could not help but notice during our travels that Jim Craig, CIO at the Janus complex and former manager of the Janus Fund itself, is walking away from the game (at least at Janus).  What prompts us to bring this up is our reflections on the institutional fund complex and its effect on the market of the present, as well as the fact that Jim is one of the few fund professionals we have had a modicum of respect for over the years.  Janus is a fund family that has changed markedly over the last decade, but is consistent with what has been the experience of the industry at large.  Asset growth has caused fund families like Janus to become walking Goliaths in the "valley of the funds".  

A friend of ours who happens to be a well known analyst at one of the large Street firms is a personal friend of Jim's.  We can remember this analyst telling us in the mid 1990's that because of the significant asset growth at the Janus Fund (at that time), Jim really viewed his job as one of protecting assets when the market played rough.  He knew that because of the fund's size, his chances of beating the S&P by a country mile through stock picking alone were diminishing with each cash inflow to the overall fund.  Today's world is a different world entirely in the "valley of the funds".  Momentum investing has largely (temporarily) replaced asset preservation or long term growth investing styles as both money and stock prices move at e-speed.  Over the last few years, Janus as been the beneficiary of a good chunk of new money flowing into the greater fund complex as it clearly adopted a quasi-momentum style across a good portion of its individual fund vehicles.  The Janus Fund today is not Jim Craig's Janus Fund of even five years ago.    

Livin' on Reds, Vitamin C and Cocaine...As we opined earlier in this discussion, momentum will eventually give way to other styles of investing over time.  Every "style" has its time and season.  The process may already be initially underway as former fast moving traffic such as Dell, Cisco, Microsoft, Worldcom, Nokia and Lucent have moved into the slow lane.  Our candidates for future price deceleration that may be running on empty right now include Intel and Oracle.  When momentum investing ultimately collapses under its own weight in a much broader context than is now being felt, how do the mega funds like Janus reallocate investment capital efficiently?  (Answer:  They don't.)  Have a look at the following table for a little perspective on some of the tremendous singular holdings at Janus:

* Remember, NASDAQ volume is often double count so much of this is overstated relative to fund holdings (which are not being double counted). 

We're not trying to pick on Janus by any means in this analysis, but rather show that the Goliaths in the "valley of the funds" are going to have a rather tough time when the momentum music stops, to say nothing of their shareholders getting roughed up a bit.  Conceptually Fidelity, Putnam, Barclays, TIAA CREF, etc. are in the same boat.  Janus has already felt the "other side of momentum" in a big way this year with the likes of Nokia, MSFT, Yahoo and Amazon.  In each case, with the exception of Dell and MSFT, Janus is among the top 10 institutional holders of the mentioned stocks.  Moreover, in stocks like Amazon, Yahoo, Microsoft and a good chunk of the others, company officials count as institutional holders ranking above Janus (such as Gates, Allen, Bezos, etc.).  In these cases, Janus' rank among mutual fund holders specifically is higher than shown in the numbers above.  Momentum works fine as an investment strategy while the music is playing.  It's when the music stops that capital vanishes in what seems a heartbeat.  We know that management turmoil at Janus has been an issue for some time now.  Nonetheless, is Jim Craig betting that the momentum style is about to go into hibernation for a while?  Only time will tell.  Although it's just another sign of the times, Craig is a loss for Janus and its credibility.  All a friend can say is "ain't it a shame".  

Eanie Beanie, Chili Beanie, The Spirits Are About To Speak...Despite another temporary (aren't they all?) cliff dive by the NASDAQ during our absence, bearish screaming during the last month has been like screaming in a crowded bus - everybody just looks at you a little funny and slowly moves away.  (Don't worry, someday bearish screaming in a true bear market will be like screaming in an airplane - everyone spontaneously joins in.)  Although there have been a good number of ups and downs over the last month, this market still acts as if it's trying to find its way home in the dark.  To us, it appears symptomatic of a longer term topping "process".  Frustrating to those who sit on both sides of the table.

In our minds, here are the current highlights de jour:

Our old friend the VIX index (OEX Volatility) is suggesting some pretty serious complacency on the part of investors at the current time.  Put premiums have shrunk pretty dramatically over the past month or so.  Over the last few years, readings as low as the current one on the VIX have roughly coincided with the approximate beginnings of market sell-offs.  The VIX is near its lows for the year that were put in over the last week.  Have investors already priced in a soft landing the end of the Fed tightening cycle, continued economic growth and sustainable low inflation?  The VIX seems to suggest as much.  Ed Hyman of ISI recently noted that his most current poll of institutional equity investors showed the highest bullish readings EVER and the most fully invested positions EVER .  That's right, EVER.  Does it get any better than this?     

Chart courtesy of Bigcharts.com 

The NASDAQ still appears to us to be key to the equation.  Possibly key to overall market confidence.  The NAZ has backed itself into a corner:

Chart courtesy of Quote.com

It's a little more breathtaking from a longer term standpoint:

Chart courtesy of Quote.com

We would expect the NAZ breakout from this formation to be violent, in either direction.

The Dow, like the NAZ and the S&P at the moment, has not returned to a new high.  We're currently in no man's land.  Any move from here to either the top or bottom of the broadening formation would be a big one.  

Chart courtesy of Quote.com

Lastly, the S&P is having trouble in the low 1500's.   

Chart courtesy of Quote.com

For now, the Dow, the NASDAQ and the S&P still exhibit distribution, uncertainty and lack of resolution to the upside.  In spite of this, complacency is significantly high as measured by the VIX.  Many technical indicators characterize an overbought market.  Is the complacency misplaced?  Finally, the NYSE AD line has seen some improvement over the last few months.  We've seen many a report trumpeting the strength of newfound breadth.  Looking at the chart, we prefer to call it a halt to erosion:

Unlike the NYSE, the NASDAQ has had no such luck in applying a tourniquet to the bleeding breadth:

We're glad to be back in the saddle.  We appreciate you tuning back in with us and we hope to bring meaningful commentary and analysis as the "greatest financial story ever told" continues to unfold before our eyes.          

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