10/3

The Sound Of Pretenses Falling
All Around

Fly Me To The Moon...It has often been said that action on Wall Street is driven 90% by perceptions and 10% by reality.  If ever a statement like this was true, it probably characterizes the last few years in our financial markets.  Certainly it isn't just Wall Street where this applies.  The political arena is perception central.  Much of corporate America these days indulges in perceptual paint by numbers in many of their press releases.  From the standpoint of simple human nature, it's no fun focusing on pessimism when being optimistic feels so good.  You remember the pop-psychology mantra of a few decades back, "the power of positive thinking".  Much of the message is constructive.

We believe that on the Street, watching for change in perceptions is crucial, if not ultimately critical.  Especially in our wired world where information dissemination is impounded in asset prices in mere nanoseconds.  Need proof?  Just take a look at the price of Apple about three seconds after the recent soft news hit the tape.  Today the herd moves fast and the herd moves hard.  There isn't much we or anybody can do about short term movements in individual securities as a reaction to specific news items.  What we hopefully can do something about is watching for change in perceptions on a macro basis.  Seeing euphoria for what it is in terms of overvaluation and likewise manic depression for what it represents in terms of under valuation and opportunity.  Of course this says nothing about timing.

We credit Ned Davis with coming up with the adage that "being right and making money" are two different things.  Personally, we live by these words.  In today's world, perceptual change regarding specific stocks can be instantaneous.  Alternatively, perceptual change regarding the macro financial market can seem glacial.  At the moment, we believe that the market is standing at a perceptual crossroads.  The concept of the New Era is being challenged daily with factual information from the real global economy.  The optimistic economic and financial market pretenses of the last few years are beginning to be increasingly questioned by a growing contingent of market participants.  Especially the contingent that is losing money.  Hopes and dreams are meeting with the harsh reality of Net Present Value.

Beatniks And Politics, Nothing Is New.  Yardsticks For Lunatics, One Point Of View...It's high time we briefly discuss the flashpoints we believe are important in assessing macro perceptual change in the broad financial market of the present.  It just so happens that they are adding up quickly.  Some self obvious and some maybe a bit less obvious.  Start counting::

     The Internet Revolution

As with all technological revolutions, evolutionary growth is never in a straight line.  Never.  Especially perceptual evolution.  Hopes and dreams characterize the beginnings of all new widespread technological achievements only to give way to the economic reality that ultimately underpins the business side of the technology itself.  Don't get us wrong, we happen to believe that the Internet is of monumental importance from a longer term global socio-economic standpoint.  It's just going to take time for the application and commercialization of the technology to catch up with the initial euphoria of investors.  The initial euphoria surrounding the economic potential of the Internet is now giving way to net present value disenchantment.  Despite it being a healthy process, the ultimate destruction in early flawed business models and the current lack of many enterprises in being able to attract near term capital disturbs early believers in the group.  The following chart is more than a clear display of investor emotions at work:

Internet stocks were bid up to levels that were far too high relative to economic reality.  In like manner, perceptual evolution dictates that they will most likely fall to levels that may be too low as the emotional move from giddy euphoria to short term investment disgust runs its course.

In the current financial market environment, the perceptual change taking place concerning the Internet revolution has relatively broad ramifications.  Ramifications in terms of hoped for sustainable productivity gains, muting of aggregate economic cyclicality, corporate profit growth, dampening of inflationary pressures, etc.  Perceptual change regarding the economics of the wired world is not isolated only to Internet stocks themselves.

     The New Era Economy

It is our contention that the US economy is exhibiting classic late cycle characteristics.  Margin pressure.  Lack of top line pricing power.  Intense price competition at the retail level.  A significant uptick in inflationary pressures (whether clear in government inflation statistics or not).  The chisel of daily economic reality is increasingly chipping away at the perceptual rock of the New Era economic philosophy.  At the current time, global energy prices and the increasingly difficult balance of domestic energy supply and demand are taking a blow torch to what was previously glacial perceptual change.

Although emotional and perceptual change can vary not necessarily coincident with underlying correspondent economic change, movement in economic reality happens directly "at the margin".  In fact some of the most powerful and telling real economic change happens at the margin.  As we have shown you too many times in the past, the American public is extremely susceptible to personal economic change at the margin given current circumstantial characteristics.  With a public loaded with personal debt, owning one of the highest level of equities as a percentage of household financial wealth in history, and having already consistently borrowed the equity appreciation from their homes over the last ten years, change in personal cash expenditures at the margin can have a quick and significant effect on attitudes.  This is where energy prices step to center stage.

If convictions regarding unlimited prosperity have not already "shifted" at the local self-serve gas station, they are sure to migrate when heating bills are received this winter.  Energy expenses at the margin are climbing significantly.  This is happening throughout the American economy.  Health care expenditures are also rising fast.  Whether it's the individual or the employer that foots the bill, someone is marginally less well off.  The change is real and it is now.  The change is felt in cash, not in retirement or investment accounts (at least not directly).  The New Economy is meeting in a dark alley with an Old Economic Reality - inflation.  The question is, "Do you feel lucky, punk?"

     The Global Economy In The New Era

Part of the new era tech dream fostered in the US over the last few years was that "the rest of the world" was so far behind us in terms of implementing technology that sales of tech equipment would mushroom for decades to come as foreigners played catch-up ball.  Conceptually, the argument has merit, but again, longer term themes never seem to play out in a linear fashion.  In the last few years, global economies have become quite dependent on the heavily credit-armed US consumer for growth as the US has rung up a quite noticeable balance of trade deficit.  In spite of no back off in balance of trade numbers (yet), foreign economies are beginning to struggle on two intermingled fronts.  As with the US, global economies are feeling the effect of higher energy prices.  Combine this with currency "fluctuations", to put it nicely, and foreign economies are experiencing significant change at the margin.

Since global oil is priced in dollars, the above chart has undoubtedly changed more than a few perceptions in the Euro-block.

The Asian countries are also beginning to feel slippage.  Let's face it, Japan is a production based economy, not a consumption based economy as is the US.  Trying to kick start the Japanese economy has been a Herculean effort for Japanese monetary and governmental authorities.  As you can see below, they still do not have the problem licked:

In fact, in the ever present mirror of historical precedent, Japan should be nothing short of a Harvard case study for US investors.  An example of seismic negative perceptual change in the early 1990's that has still not experienced either perceptual or real recovery.

Lastly, you may have noticed that the Korean government is coughing up $44 billion in an attempt to shore up capital in its banking system.  This was just announced a few weeks back.  The equivalent in the US on a bailout-to-capital base ratio would be about $880 billion, give or take a few billion here or there.  The global anecdotes of economic slowing are staring US investors in the face.  The perception of a tech driven New Era capital spending binge for the global economy is fast becoming a memory.

     Global Technology

We've spent enough time already relating technology dreams to the realities of the changing global marketplace.  Globally, the most important question in changing perceptions for tech investors involves capital spending.  If global economies slow to the point where broad capital spending is seriously diminished, technology earnings woes have only just begun.  At best, the rate of change in revenue and earnings growth rate will be headed for a southern vacation.  As you may have noticed, tech stocks in foreign countries have been in their own bear markets for some time.  The JASDAQ (Japanese tech laden index), the KOSDAQ (Korean tech heavy index) and the European tech indices all peaked early in the year and continue to descend.

At ContraryInvestor.com, we are practicing market agnostics.  The market will always know more than we do.  We hope to work within a framework of intelligently researched and informed opinion, but we know we cannot "force" the market into our way of thinking.  Conceptually, we continually try to listen to what the market is saying.  At the moment, global market technology indices are saying one of two things.  Either the calamity in stock prices is foretelling a revenue and earnings slowdown.  Or, the collapsing stock prices will cause a slowdown given the wealth effects emanating from current financial markets.

We have the queasy feeling that confidence in equities broadly is heavily tied to the confidence in technology stocks.  After all, what group was more responsible for the NASDAQ's 86% moon shot last year?

     Confidence In Wall Street

Perceptual confidence in Wall Street is clearly eroding.  Primarily confidence in the analytical community and Wall Street research in general.  Investment professionals who have been in the business for a while will openly admit to this (as they should).  Unfortunately, the Street players have allowed analysts to move into the role of cheerleader over the past few years.  Research reports justifying astronomical valuations on Net and Tech stocks were flying right and left - at the exact top.  For a while now, even the ultimate cheerleaders themselves, the folks on CNBC, have been making fun of the analysts with their video of penguins diving off of the iceberg each time a news related stock price tragedy is met with a plethora of "un"timely analyst rating downgrades (after the fact, of course).

We sat in utter awe a few years back as analyst newly proclaimed twelve month target prices on stocks were met in twelve days, if not twelve hours.  In a perceptual about face, the public is learning to distrust analyst commentary, recommendations and forecasts after being burned in Net issues, the DRAM players, semi-equipment stocks, and now broader big tech in general.  In the end, Wall Street really only has itself to blame.  Wall Street is in the business of selling financial products, so it is really caught in a catch-22.  After all, when was the last time you visited a used car lot and had the salesperson tell you there simply weren't any good buys on the lot at the moment? Answer: Never.

     Is The Financial Market Really A Freely Operating System?

This is a perception that is really changing more among investment professionals than among the mom-and-pop investment community.  Even though the data is plainly available, many investment professionals have chosen to ignore it for a good while under the "don't rock the boat" thesis.  We are not in any way suggesting here that there is come type of conspiracy to manipulate the domestic financial markets, but rather that US Fed and Treasury Department can and do effect the broader financial system by their actions.  It is simply no secret that the Fed has often times provided great amounts of liquidity during periods of actual or anticipated market distress.  Lowering interest rates during the LTCM debacle was not done to slow an economy spiraling upward.  It was done to ensure market stability through the band aid of excess liquidity.  Allowing the money supply to grow at double digit annualized rates into the (Y2K) December 1999 year end was done for no other reason than to hedge against the unknown.  The recent G3 coordinated action to attempt to shore up the Euro (right in front of the Danish Euro inclusion vote) was open manipulation.

Is all of this incremental action bad?  Of course not.  But what is bad is that it breeds the perception that the Fed, Treasury, and/or global monetary authorities will always be there to bail the financial markets out of any kind of trouble.  The colloquial term on the Street currently is the "Greenspan put".  Unfortunately this is one perceptual leap of faith that will someday fail the test of confidence.  Throughout history, this kind of perceptual reliance on monetary authority bailout has always been Achilles-heel thinking.  Always.

     Stocks Are The Best Long Term Investment

Conceptually we do not argue with this statement.  It just depends on your definition of long term.  The public is slowly learning that long term investing is not shooting fish in a barrel.  Especially the holder of a diversified basket of equities.  Fifty percent price depreciation is not uncommon in today's world in a very short space of time.  In the last 12 months, holders of ATT, Lucent, Xerox, Worldcom, Apple, P&G, the semiconducter equipment crowd, and the list goes on and on, can bear witness to what it feels like to lose 50% of your (pre tax) money from the highs.  This is the first time in many moons where market averages have sold off and not returned to news highs within a matter of months.  That perceptual overhang alone is nothing short of elegant in its utter simplicity.  Despite the current pop-investment mantra of "be a long term investor", we have yet to see psychological support groups spring up nationwide as a testament to current market activity.  Who knows, maybe that is the future of modern day "investment clubs".  It would sort of give a whole new meaning to the term, wouldn't it?

In the late 1920's, popular perception was that stocks were the best long term investment.  In the early 1970's, popular perception was that stocks were the best long term investment.  In the late 1980's in Japan, popular perception was that stocks were the best long term investment.  When are stocks not the best long term investment?  Well, just ask the author of the 1982 Business Week article entitled "The Death of Equities".  So once again, when are stocks not the best long term investment?  Answer: At the bottom.  Perceptual change is a powerful construct, isn't it?

We're not predicting the end of the world in the financial markets.  What we are saying is that it appears that perceptual change is currently appearing on a multiplicity of fronts.  More fronts than at any time in the last few years.  Never underestimate the power of perceptual change in effecting financial asset prices and crowd behavior.  If domestic investor perceptions ahead turn negative on balance, real selling will probably not be too far behind.  Believe us, we have by no means experienced real selling in the current market.  We have experienced lack of buying corrections, but not a real selling bear market.  Corrections are like being thrown into the deep end of the pool and hoping to swim.  Bear markets are like being thrown off a cliff and hoping to fly.

Fibonacci Finale?...The following is an update of the very important chart Tim produced for us last week.  The 3350 number on the NDX is crucial.  A sustained break below that level could mean serious blood is shed and possibly seriously fast.  You can bet the technicians of the world are watching closely.  We suggest you do also.  

The Fed Takes A Pass...No we don't mean another coupon pass.  There have been so many of those over the past few months that you can basically set your watch by them.  To us, the Fed is becoming trapped in a late stage credit cycle monetary policy dilemma.  It was certainly no surprise that the Fed took no action Tuesday at the FOMC meeting, but we are not expecting any rate cuts (or hints thereof) anytime soon.  Barring a bone shattering market plunge, the Fed would surely incite inflationary pressures significantly if it eased.  With upward energy price pressures, a still tight labor market, and real estate still smoking, the last thing the economy needs is a consumption stimulative shot of monetary caffeine.  Moreover, an ease may possibly provoke a domestic eco-financial disaster - the reckless and indiscriminant global dumping of dollars.