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Weekday Commentary from Michael Hartman
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The Semiconductor 2-Week Ride
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Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
Week in Graphs 
Storm Watch 
Geopolitical News 
Energy 
Precious Metals 
Raw Materials
Friday, November 22, 2002
Run Your SOX Off
I was absolutely captivated this week to watch the movement in the Semiconductor Index. If you look at the two-week chart of the SOX Index above, you can see the back to back gains of 8% for Wednesday and Thursday of this week. Over the last six weeks the SOX is up 75%, in two weeks it’s up 29%, and in two days this week it’s up a whopping 16%. If you bought your call options on Monday or Tuesday, you should be smiling all the way to the bank!
Yesterday I wanted to take a closer look at the NASDAQ most active list and specifically PMC-Sierra since it was up an incredible 23% for the day by adding $1.44 to close at $7.73 per share. Even better, on Wednesday PMCS opened at $5.51 per share which means it had a gain of 40% in two days....Wow! From that point I went on to look at a five year chart of PMCS only to find that the 40% increase in two days didn’t even show up. It looks like a flat line. In March of 2000 the stock went over $250 per share then fell to $2.70 per share in October of this year—a loss of 99% top to bottom. Putting the two-day gains of 40% into a broader perspective helps to explain the extreme volatility.
When I looked closer at the 50 most active NASDAQ stocks it was clear to see that the movement in PMCS was consistent with many of the Hi-Tech High Flyers. With a cursory glance at the page I noticed that most of the stocks were priced under $10 per share. In fact, 36/50 are below $10 per share and 28/50 are below $5 per share. You can get some big percentage moves if you are willing to speculate on the fallen angels of the dot-com mania. The way I read the whole thing is that people want their money back! Investors who lost big in the NASDAQ meltdown seem to be pounding on the glory stocks of old. I still have two big questions. Where is the demand for semiconductor chips going to come from? Where are the earnings? PMC-Sierra has no P/E ratio because over the last year they have negative earnings to the tune of -$3.80 per share.
Now back to the broader index of the SOX. Is this for real? Is the bottom really in? Let’s take two different looks at the SOX Index. The first chart shows the SOX three-year daily in logarithmic format and clearly defines the bear market trend channel. While the 75% gains of the last six weeks is a big move, the index is still confined to its bear market channel. Can it break out to higher ground? The second chart is the same three-year time period, however please note that it is a weekly chart in linear format. Once again, the recent gains are still contained within the downtrend. In technical analysis, a descending wedge is considered a strong reversal formation, but look what happened in February of this year. The blue line indicates the original downtrend line that was broken back in February, but there wasn’t much follow-through. The index popped out briefly, only to find lower-lows once again. Even if the SOX can break out beyond the green resistance line, I would expect to see a similar pattern that followed the breakout earlier this year. Is this the real deal, or just another bear market rally? You judge for yourself.
Another thing to note is that both the daily and weekly stochastics (momentum indicator) are at the high end of the range which says that the stocks are short-term overbought and due for a pullback. Also, if you are new to charting, the big difference between linear and logarithmic formats is simply that the log format reflects price changes as a percentage rather than a straight line look. As a general rule, I like to see the charts in both formats to see if they are singing the same song. It’s probably a good idea to use linear for one year or less, and use logarithmic for longer time periods, especially five and ten-year charts. One thing that I really enjoy about technical analysis is the fact that it is an art more than a science and there are many different schools of thought.
In Search of Returns
Where did the money come from to continue the rally in stocks? It appears that most of the fuel came out of Treasury Bonds. With bond yields in the 3-5% range, take out taxes and adjust for inflation, real returns are negative in some cases. This week there was roughly $20 billion in new issues of corporate bonds which was competing with treasuries for available capital. Investors have been selling Treasury Bonds to buy the higher yielding corporates and chasing stocks to higher levels. If you have been dependent on fixed income securities for your livelihood, you must agree that healthy yields are difficult to achieve in this environment.
Taking a quick look at the chart of the 30-year Treasury Bonds, we can see the consolidation pattern that has emerged. This week bond prices have broken through the short term uptrend that began in mid-October, and appear to be headed for lower levels. This is not a good development for the real estate markets. Lower bond prices mean higher mortgage rates. Another reason cited for the falling bond market was a better than expected report on unemployment. Initial jobless claims fell 25,000 to 376,000 for the week ended November 16th and continuing claims fell 61,000 to 3.582 million in the week ending November 9th. With the lower than expected unemployment claims we still got news of further layoffs from companies such as Boeing, United Airlines, UBS, and Morgan Stanley.
There are two things that I hold suspect in the employment numbers. First, over the last two years how many people have exhausted their benefits, still do not have a job, and are no longer part of the unemployment statistics since they are no longer receiving benefits? Second, where do we find the statistics for workers that are “under-employed?” With all the layoffs in Silicone Valley and the 60,000 stock brokers and analysts that have been laid off on Wall Street, have they found jobs making the same or better salaries? I know a good friend that is a CPA by trade that is now driving a taxi cab just to make enough money to pay his mortgage……now that is serious under-employment and will definitely slow down the Holiday Shopping Season.
In many of the past WrapUps, you have read Jim Puplava’s commentaries on the Plunge Protection Team, otherwise known of as "The Working Group on Financial Markets." This group definitely exists and most definitely intervenes in the markets. Most recently it has been suspected that they have been propping up the stock market via the use of derivatives. I don’t doubt for a minute that it’s true, but to what extent? Then you can do extensive research on the purported suppression of the gold price. Take a look at the Kitco gold chart for the last three days. Very nice spike to close the week above the $320 level, but also notice the repetition in trading pattern prior to the late spike. Tuesday the graph looked exactly the same with the “dome” controlling the price lower for the close in New York. Does this look like a chart where the commodity is trading freely?
The Great Experiment
I think it is at least safe to say that we live in an environment where the financial markets are “managed.” In my opinion, the Powers-That-Be of the Financial Markets are playing with fire. Market interventions tend to cause more problems and misallocation of assets than would otherwise occur if the markets were left to cleanse themselves and get back into balance. Money flows like water and water seeks its own level……..likewise, money flows will eventually seek their own levels. The natural market forces will prevail in the long run. The biggest thing that has changed in the last 30 years is the fact that the global monetary system is based on fiat currencies and floating exchange rates since 1971. In the last ten years we have witnessed a proliferation in “financial engineering.” If you can put the whole monetary system (free-floating fiat currencies and derivatives engineering) into historical perspective, you can see that this is truly a Grand Experiment!
I was most disturbed this week when I read an article on www.gold-eagle.com by Hans Schicht titled, “The Long Bond Mystery.” You see, it has always been my understanding that the Fed sets short term interest rates while the market itself determines long term interest rates. I’m not convinced that is true any more. The following is an excerpt from Hans Schicht’s article.
“The volume of US long bonds outstanding is mind-boggling and its liquidation will be a major undertaking. I wondered how it was all planned, as the FED and the Treasury have not been too forthcoming in informing the public. I also wondered about the amounts of liquidity appearing lately from nowhere and being injected into the markets and the economy as a whole.
I have a deep rooted suspicion, that in the mid nineties, a mechanism was established, probably on advice of Rubin, with the aim to underpin the value of the US government bonds by interfering directly in the bond market and which action would simultaneously create unlimited liquidity.
At the same time as there must have been a secret mechanism put into place by the ESF, the Treasury and the FED to depress the gold price in the mid nineties, a special off-balance sheet fund looks likely to have been created by the FED, with the purpose to stabilize and to control fluctuations of the treasury bonds, through a gradual monetization of the long bond, on the home market.
It should be remembered that bond trading on the home market does not have direct influence on the exchange rate. Whereas bond trading outside the US borders, yes, will affect the rate.
Regarding foreign exchange, all dollars circulating outside the borders of the United States and all the dollar bonds held by foreigners should be seen as one and the same package of claims outstanding against the United States. And as the bonds in the package represent the bulk of the package, they do carry a greater weight by far in the valuation of the dollar rate of exchange, than the total amount of current accounts in dollars and cash held by foreigners.
Under normal, free market, conditions, the fluctuations in the dollar interest rates are the ones, which determine the market value of the US bonds. However, if my suspicions turn out to be justified, then the FED, in addition to its published official bond dealings inclusive the repos, has turned the market upside down by having begun buying back the long bond directly through such secret off-balance sheet fund. Upside down, because not any longer would the interest rates be setting the bond prices, but the bonds would now set the interest rates!”
Federal Reserve Governors on Speaking Tour
It has also been curious to me that the Governors of the Federal Reserve have been out in force this week giving speeches. On Tuesday, Mr. Greenspan basically said that there is a lot more we can do to help the markets than simply lowering interest rates. Then on Wednesday Fed Vice Chairman Roger Ferguson, Jr. gave a speech that addressed dynamic hedging of mortgages, risk measurement systems, and credit derivatives. In his conclusion he said, “Because these techniques are relatively new, regulators and market participants must work to build their understanding of how they function in differing economic environments.” I would call that an experiment if we are still working to understand how financial engineering functions.
Finally, on Thursday Fed Governor Ben Bernanke gave a speech before the National Economists Club in Washington, D.C. where he said, “If faced with deflation, the Fed intends to simply print money, or in other words, monetize US government debt, private mortgage debt, corporate debt, and foreign government debt, until the problem goes away, up to and including a severe devaluation of the dollar that would effectively transfer the assets of foreign dollar holders back to the US, and result in the central bank owning a significant portion of the private assets (homes) of the US. There are other interpretations of this, but think about the Fed simply printing money to buy debt, like mortgages, corporate bonds, etc. Interest rates of the longer bonds would not rise, because the Fed would simply print dollars to keep buying them at a ‘pegged’ interest rate. What does this do to the dollar? Who exactly ends up owning a significant portion of US ‘private’ assets?”
I see all of these developments as critical to know if we are heading towards inflation or deflation. By all counts it appears that the Fed would rather err on the side of inflation. It’s inflate or die! Put another way, our system cannot function in an atmosphere of deflation. Since we live in a debt based system where money is borrowed into existence, the monetary base must continue to expand or there won’t be enough money to pay back the debts plus interest. Since we have seen a number of debt defaults plus the eight trillion dollars that has evaporated in the stock market, the Fed must create as much new money as the money that is being destroyed. Now that we have lower interest rates (cheaper money) the next thing for the Fed to do is pump liquidity into the system.
When I read the article on the Long Bond, it all started to make a lot more sense to me. While I was disturbed that the markets weren’t trading freely, I was also put at ease because it helped to explain some things. For quite some time I have noticed the “S” shaped yield curve. It was more pronounced before the last rate cut, but you can see where the curve is “inverted” at both ends and normalized in the middle. If the Fed is in fact controlling the price of the Long Bond, it means that they are controlling both ends of the curve. This is clearly a development that I will be watching closely.
Closing Numbers for the Week
The Dow added 226 to close at 8805 for a gain of 2.6%, the NASDAQ grew by 58 points to close at 1469, a gain of 4.1% and the S&P500 tacked on 21 points to close at 931 for a gain of 2.3%. For the week ending November 20th, Trim Tabs estimated that all equity funds had net outflows of $3.2 billion after inflows the prior week of $2.6 billion. It has been a great run for the stock market. Let’s watch next week to see if there is still enough fuel to drive the indices to higher levels.
Overseas Markets
European stocks rose for a second week after companies including Royal Philips Electronics and ING Groep forecast higher sales or said cost cuts will help earnings to improve. The Dow Jones Stoxx 50 lost 3.88, or 0.1% to 2681.03, after rising to a 10-week high yesterday. Seven out of the eight major European markets were up during today’s trading.
Asian stocks rose, led by Sony Corp. and Taiwan Semiconductor Manufacturing Co., after economic reports in Taiwan, South Korea and the U.S. indicated a recovery in demand for the region's exports. The Nikkei 225 Stock Average advanced 1.2% to 8772.56., while the Topix index added 1.3% to 859.05.
An Attitude of Gratitude
Thanksgiving is one of my favorite holidays. It’s a good time to see family and friends, sit down to a big meal, count our blessings, and give thanks for all we have. We live in a great country with incredible opportunity, freedoms, and luxuries. There are millions of people around the world that don’t have it anywhere near as good as we do. We tend to take it for granted that we have hot and cold running water, plenty of food, comfortable beds to sleep in, electricity, cars, entertainment, et al. Many people don’t have those things. Since you are reading this site, it’s probably safe to assume that you have investment capital…………in that, you can be sure you are one of the more fortunate ones here in the US. There are more people that just live paycheck to paycheck. I know I am at my happiest when I am feeling grateful. Right now I can tell you that I have an awful lot to be grateful for. I hope you are able to share the same attitude of gratitude, ‘cause it sure feels good. Have a very Happy Thanksgiving!!!
Copyright © Michael Hartman
November 22, 2002
mhartman@puplava.com