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from Jim Puplava
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Market WrapUp for the Week
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Week in Graphs 
Storm Watch 
Geopolitical News 
Energy 
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Thursday, November 7, 2002
A Matter of Spin & Perception
The markets move on perception, and perception is influenced by how the news is presented. One day bad earnings can drive down markets; while the next day similar bad earnings can trigger a rally. In October Intel’s disappointing numbers triggered a market selloff. The very next day IBM’s numbers triggered a market rally. IBM’s earnings were down 18% and they mentioned in their footnotes that they would need to make a $1.5 billion contribution to their pension plan. The news coming from IBM was consistent with most of the news coming out of the tech sector. Sales are sluggish and there has been no significant pickup in demand. Companies that are making a profit are doing so mainly through cost cutting. They are slashing costs by trimming back payroll. The point to understand is that there has been no news that would have indicated the economy or profit picture has changed. In fact, the economic situation has actually worsened. Why the market rallied on IBM and sold off on Intel is all part of how the news is spun and perceived.
Yesterday, like IBM last month, Cisco beat estimates by a penny. Today stocks sold off because of what Cisco said about future sales and their book-to-bill ratio. Cisco’s presentation is consistent with what most companies have been saying all along since the beginning of the year. It is all part of the earnings game played each quarter. The spin, the change in perceptions and all of the trading that results from this change is good for business at a time when most business on Wall Street is contracting. Wall Street loves and profits from volatility. The more volatile the market becomes, the more profitable it is to trade. The Street may spin a lot of propaganda about buy and hold, but in reality they practice just the opposite. This is a bear market and the only game in town is to trade, unless you’ve invested in the new bull market in commodities and “things.”
However, at the moment Wall Street isn’t selling things. Most firms abandoned their commodities trading departments years ago. Commodities have been in a bear market for decades, so most firms don’t talk about it. When was the last time your broker called you up and talked about oil, natural gas, gold, silver, cocoa, coffee, and grains? It is unlikely you have received that call. Analysts and anchors pay very little attention to the fact that the AMEX Gold Index is up over 88% this year. You don’t hear much about the fact that the CRB Index is up close to 19% this year, or that oil and natural gas is up over 25%. Instead, all you hear is that IBM beat estimates and that most companies beat estimates, which is always the way it plays out each quarter. You don’t get real news that is helpful for investing; you are told how the market has bottomed or why stocks are cheap. No one explains that real PE ratios, if you can measure them with so many forms of earnings being presented, are still at historically high levels. You don’t hear stories about how book values are being destroyed as one company after another writes off impaired assets. Book value is the shareholders’ bank account at the company whose shares he or she owns. Warren Buffett considers book value one of the most important yardsticks by which management is measured. It measures what is happening to the real value of the company.
Let The Next Round Begin!
Now that this quarter’s earnings game is over, the next round of the game is being planned. It is like politics where the next campaign is already beginning. Analysts have already reduced fourth quarter estimates and they will be reduced further as we get closer to the end of the year. Earnings estimates will be cut drastically in January just before actual earnings are reported. They will be lowered to the point that companies will once again beat estimates. What is bad will be made to look good, and that is all part of the game. The only problem with this game is that it is attracting fewer suckers. This last quarter Wall Street essentially played against itself because John Q wasn’t buying. Mutual fund companies continue to report outflows from equity funds, so instead of playing the sucker’s rally, as they have been trained to do for so long, more and more investors are folding the cards and quitting the game. They have been dealt a losing hand for three consecutive years.
Now that the quarterly earnings have been reported, the real news is coming out. Wal-Mart reported same-store sales slowed in October as the consumer retrenches on his spending now that mortgage rates have risen. Home bankruptcies jump 8% from the previous quarter. Bankruptcy filings and chapter 13 filings are at record levels. Global Crossing, the fiber optic operator that filed for bankruptcy protection in January, said it would take a $10 billion write down of its network assets. J.P. Morgan had to deny rumors it had suffered large losses on gold trades. Reuters reported rumors have been flying throughout Europe that the world’s largest holder and writer of derivatives has lost between $17-70 billion in gold trades. Morgan owns the largest derivative book in gold derivatives. Tenet’s CEO Dennis and OC officer Mackey left the company amid Medicare pricing probe. The SEC is suing Beacon Hill hedge fund manager for failing to disclose losses to investors. Westar’s Energy’s CEO is indicted on bank fraud. FleetBoston mangers in Argentina were charged with fraud and withholding money. Finally, the US and the UK are ready to attack Iraq if resolution is blocked. In other words, we are back to normal now that the earnings season is over. The news will be allowed to play out without spin.
One story that did not get a lot of play is the failure of the Bank of England and the ECB to lower interest rates today. This will put additional pressure on the US dollar, long-term interest rates and commodity prices. The dollar fell against the Euro and the British pound today in currency trading. As the charts above of the German and US bond markets indicate, rates in the US have become less competitive and make the dollar vulnerable to a fall. The Euro has experienced its longest running winning streak versus the dollar since its inception. Short-term rates in Europe are now favored by big money because of the huge yield differential. The Euro has risen against the greenback for the seventh consecutive day. The ECB decided to keep interest unchanged at 3.25% versus rates in the US, which are at 1.25%. Short-term Euro deposits now pay 1.74 percentage points above US rates.
In today’s bond market trading the gap between the two-year note and the 10-year note narrowed. It was the sharpest jump in one day since the aftermath of the 1987 stock market crash. The yield on 10-year notes is important since they drive mortgage rates. Mortgage rates have jumped these past few weeks as a result of the plunge in bond prices. It looks like Mr. Greenspan is trying to keep the mortgage bubble alive. Consumer confidence is plunging along with consumer spending. A rise in interest rates, especially the 10-year note, could put an end to the refi boom, which has fed into consumer spending. This would be especially important now that we are entering the important Christmas retail season. The consumer is tapped out on his credit cards, installment debt is at records, and not even free money from auto companies is attracting buyers into showrooms. In an effort to keep the bubble alive, mortgage rates will have to be engineered lower.
Stretch Marks & Stress Lines Emerging
Another reason for lower rates is that the financial sector is showing signs of stress as these graphs of J.P. Morgan, MGIC, Fannie and Freddie are showing.
By lowering rates half a point, the spread between what banks pay depositors and what they can charge borrowers has widened. This helps to reliquify banks and drive up profitability. The lower rates may be helping the banking sector but it is hurting corporations. Lower rates have not flowed to the corporate sector where yield spreads have widened between treasuries and corporate and junk bonds. Lower rates are going to impact earnings as more companies are forced to contribute more to their company pension plans to account for losses and lower returns. IBM filed a shelf registration today to sell 19.3 million shares of stock to help fund its pension obligations.
Lower interest rates are also impacting savers as they see their returns dwindle to nothing. It is hard to find a safe and liquid place to invest cash in these yield-starved days. One-year CD rates are taking a big hit as a result of yesterday’s rate cut. Before the rate cut, the national average on one-year CD’s was 1.68%, which is just slightly above the inflation rate of 1.5%. After backing out taxes, savers actually have a negative return. The half a point rate cut has now put 73 money market funds in jeopardy. The Fed’s rate cut is penalizing savers at the expense of borrowers, as the rate of money is kept artificially low. The real rate of interest in a free market would be determined between willing savers and borrowers. By creating money out of thin air the Fed has moved the rate of interest to below market rates. Its intervention into the credit markets by lowering rates and allowing banks to expand credit is setting up the stage for the next bust. The Fed’s rate cut is designed to keep a nation that is addicted to credit on a life support system by expanding and giving the addict more of what it craves.
Today's Market
In today’s casino, the stock market results dealt investors big losses. All three major indexes tumbled suffering the biggest decline since October 16th. The NASDAQ was the day’s biggest loser giving back 3%. The markets were also rattled after the President’s press conference where he said Iraqi dictator Saddam Hussein faced “serious consequences” if he didn’t permit unfettered arms inspections. The upcoming war with Iraq is back on the front pages. Today’s big losers were banks and retailers, and the biggest winner was gold. New conspiracy and fraud charges against Westar CEO, and against executives of FleetBoston’s Argentina executives brought back to memory the scandals and frauds from earlier this year.
Volume came in lower with 1.44 billion shares on the NYSE and 1.75 on the Nasdaq. Market losers trounced winners by a margin of 21 to 11 on the big board and by 22 to 11 on the Nasdaq. The VIX rose .80 to 35.28 and the VXN rose 3.84 to 53.90.
Overseas Markets
European stocks fell, led by insurers, as Aegon NV said it was setting aside more money to cover losses on stocks and bonds. Telecommunications equipment makers including Alcatel SA declined after Cisco Systems Inc. said sales this quarter may drop for the first time in a year. The Dow Jones Stoxx 50 Index slid 2.1% to 2536.58. All eight major European markets were down during today’s trading.
Japanese stocks fell after Cisco Systems Inc. said second-quarter sales may drop for the first time in a year. Computer-related shares such as Sony Corp. led declines. The Nikkei 225 Stock Average lost 0.4% to 8920.44. The Federal Reserve's larger-than-expected half a percentage point reduction in the U.S. benchmark interest rate spurred stock gains in Taiwan and the Philippines, where the main index had its biggest rally in three months.
Copyright © Jim Puplava
November 7, 2002
