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Today's Market WrapUp |
Garbage In - Garbage Out
This weekend’s edition of Barron’s featured a story on analysts’ reports. The gist of the article was why these reports stink in terms of accuracy. In too many cases analysts try to project a degree of certainty in a world that is uncertain. Flaws in fact gathering, assumptions, and personal biases enter into the equation and produce results that are less than certain much less accurate. The article warned of analysts trying to predict so many variables without the accompanying input. “People who try to predict so many variables fall into a trap… They think that more detail is actually going to clarify the picture, when sometimes the best picture is a very sketchy picture.” Wharton finance professor, Simon Benninga, quoted in the article counsels his graduate students to keep their models simple so as not to miss the forest for the trees.
The article goes on to tell of robust projections made by many Internet analysts and tech analysts over future growth of such companies like AOL Time Warner. The models forecasted growth rates, cash flow, and a myriad of other variables as much as 100 from inferences on past data. The forecasts, as detailed as they were, projected a degree of certainty when none existed. As if to be reminded of this fallacy, AOL Time Warner said today America Online, the biggest Internet service provider, might see advertising revenues plunge as much as half next year. The result is that profits from that division could be down by 15 percent.
When Fools Rush In...
This story highlights one of the problems with today’s investment markets. So much of what happens in the financial markets is based on estimates and projections, which invariably are wrong over 80-90 percent of the time. Yet each quarter billions of dollars in investments are reallocated based on this company or that company meeting or beating expectations. It has become a fool’s game played repeatedly by both professionals and non-professionals each quarter to little avail. Ben Graham, in the writing of his last investment book the “Intelligent Investor,” believed it was impossible to make accurate projections of future earnings. He didn’t trust the predictions made by other analysts or even his own ability to make accurate projections. Towards the end of his life and after a successful career on Wall Street, he come to the conclusion that it was far less risky and more profitable to pay more attention to what is paid for an asset rather than to invest in a stock based on future projections that may never materialize. He advised, “The habit of relating what is paid to what is being offered is an invaluable trait in investment. In an article in a woman’s magazine many years ago we advised the readers to buy stocks as they bought their groceries, not as they bought their perfume. The real dreadful losses of the past few years were realized… when the buyer forgot to ask ‘How much?’”
I’m reminded of what Graham wrote again as I have watched with amusement this latest “collective leave of common sense” rally since mid-October. It reminded me of late 1999 when the herd moved in mass and bid up the shares of companies beyond any measurable objective, reason, or expectation. The SOX Index -year chart illustrates this point. It was not unusual to see this index rise 8 percent a day as fund managers, playing with investors’ money, moved en masse and bid up these shares in a brief moment of lunacy. Their collective thinking helped to move this index up 66 percent on no major fundamental improvement in earnings prospects. In fact, the P/E multiple on the SOX is negative because most of the companies that make up the index have lost money. However, if you are going to speculate, and that is what they are doing, you need a large liquid sector to pour in billions of dollars. The question that should now be asked is what happens to prices when more bad news emerges from the sector or if the herd begins to move en masse out of these stocks?
I have long contended that earnings expectations were far too high for the fourth quarter. The same applies to economic growth rates. Obviously a slowing economy would translate into lower profits. That is what we are now seeing in both the economic numbers and the earnings confession period that has now begun for the Q4 earnings season. Companies such as AOL Time Warner, Ford Motor, GM, Chrysler, Tenet Healthcare, and Nokia were all issuing Q4 and 2003 warnings today. The next couple of weeks should be a down period for the markets as many companies air out the dirty laundry in order to bring down analysts’ expectations. Wall Street firms will lower estimates to a point that when actual earnings are reported, the companies will be able to exceed expectations.
Trading This Market Requires Multiple Skills and Finesse
As I have written so many times in these daily missives, this market has turned into a casino and investing has become a speculator sport. Markets aren’t trading on values or fundamentals. Hope and hype is what is moving this market. The fact that this remains unrecognized is a major problem for investors. To quote Graham again, “For indeed, the investor’s chief problem—and even his worst enemy—is likely to be himself. The fault, dear investor, is not in our stars—and not in our stocks—but in ourselves.” To trade a market knowing that one is speculating is one thing. To do this requires supreme technical skills, knowledge of fundamentals, emotional discipline, and money management skills.
To move in this market without these skills is a dangerous sport. That is why I have advocated that an investor is better off staying with the primary trend of the markets or simply staying out. So much of what I see today is unintelligent investing. Graham cautioned investors of this misunderstanding of investing and speculation. He warned that, “…there are many ways in which speculation may be unintelligent. Of these the foremost are: 1) speculating when you think you are investing; 2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and 3) risking more money in speculation than you can afford to lose.” To speculate successfully you most exert supreme emotional discipline. To invest you must also supply emotional discipline. However, there is one major difference between the two when investing: when it is applied intelligently as to price paid for an investment, time becomes an ally; when speculating, time becomes an adversary. Knowing the more manageable of the two is an important key to success.
Market Mayhem with Money Madness in Spades
Watching today’s events unfold, the investment battlefield was full of minefields. All the major indexes fell hard with the NASDAQ losing 2.4 percent. The bond market ran into difficulties but managed to recover slightly in the final half hour of trading. The dollar fell along with other paper assets. It was a bad day for paper and a good day for “things.” This new bull market in “things” has still gone unrecognized by the financial markets. Gold, energy, grains cocoa, coffee, and orange juice are all up this year. However, there is little talk or mention of this by the financial media. The reason we cover this topic so often is it is my belief that in the next decade the real fortunes will be made in things. (Please see The Next Big Thing.) We now have on record the Fed’s intention to do all that is within their power to prevent deflation from occurring. They will print, monetize, trash the currency and inflate at will in an all-out effort to prevent a cleansing process from taking place. If they need to print wheelbarrows full of money, they will do so. If you still believe in paper, I would suggest you visit your local Home Depot and buy a wagon or a wheelbarrow, for you may need it when this Grand Experiment is over.
Getting back to “things,” as long as the markets remain open, global money will gravitate to where it can find its highest return. With central banks hell-bent on providing ample supplies of the paper-stuff, a fully deflationary environment will not be possible. This issue will be addressed next year in the final epilogue to my Perfect Financial Storm Series and the third part of PowerShift (articles that have been delayed due to research). Suffice to say at the moment, there are plenty of examples throughout all of history when deflation and inflation existed simultaneously. The Fed’s recent speeches convince me that my Perfect Storm Thesis will happen when this process finally plays itself out.
We Are in Transition
As I wrote in "The Next Big Thing,” when one bull market comes to an end, another emerges to take its place. It is seldom in the same asset class. Throughout history the markets swing back and forth like a pendulum between paper and things as shown from this graph taken from "Riders on The Storm." A growing population in the developing world and the environmental movement are two major factors that will bring about a rise in prices in most commodities. If I had to put investment priorities into perspective and rate them in terms of highest return over the next decades, they would be as follows:
1) Precious Metals
2) Energy: oil and especially natural gas
3) Water
4) War Stocks
The following charts of cocoa, wheat, gold, oil, and natural gas are just a prelude of things to come. The US and Western Europe will be competing for all of these things with the world’s largest economic power, China, in this new century. At a time when Western oil production will go into serious decline, China’s voracious appetite for energy will more than double, then triple. The only source available large enough to supply this demand will be the Middle East. Soon, in this next decade, China will become the largest consumer of energy in the world. For this very reason, Western and Eastern nations will all want a stake or say so in what happens in this region. The present war will be one of many to come to plague and disrupt the supply of energy around the globe. Any nation that is not self sufficient in energy will pay a terrible price in economic terms for this lack of self-sufficiency. We in the West must learn to become self sufficient in energy if we are to see our economies prosper in the next decade. Without a cheap supply of abundant energy, our economies will stagnate.
Where The Wise Will Tread
The best part about my thesis in “The Next Big Thing” is that the herd has yet to recognize it. Many of these asset-based companies, whether in metals, energy, water or commodities, remain undervalued and are now under accumulation by smart money. The fact that shares in many of the metals stocks have gone up last year and this year has yet to convince the crowd. Most investors trade them but don’t, in reality, believe in them. This is obvious by reviewing the e-mails to James Sinclair on our site, or watching the charts of most high quality metals stocks. The same is true of energy and natural gas. Wall Street is still going with the quick war and plenty of oil scenarios. Very few analysts have studied geology. Wall Street still believes that there is plenty of cheap oil around and plenty natural gas left. The problem is that it won’t be cheap.
It may take a while for the rest of the market to wake up to these facts. But for those who can think beyond the next day, week or month, there are, IMO, going to be big profits made in these areas. There isn’t time in daily missives to go into all of the particulars of why. That is the purpose of the Perspectives and Storm Updates. However, I can say this now—that the supply of gold and silver on the exchanges aren’t large enough to cover short positions or handle any investment demand coming from the general public. Only the big boys have been buying and when they do, they cover their footprints. You can follow their footprints in chart patterns, but even they can be deceptive because a lot of trading in this market is done outside the market. I do believe, however, when the masses wake up to what has been done to their currency and what has become of the value of paper, there is going to be a giant scramble for the exit gates out of paper and a stampede through the narrow gate of precious metals. To deny this eventuality is to admit ignorance of monetary history. Very few give evidence of any paper currency that has been long lasting or enduring throughout the centuries.
Today's Market
The markets took a real drubbing as one company after another confessed to lower earnings for this quarter and next year. On the economic front, the pace of layoffs, although slowing down, still came in at 157,508 job cuts last month. Investors will be watching this Friday’s unemployment report by the government. The combination of earnings confessions, along with weaker economic data, gave way to heavy selling by investors. In addition to earnings warnings, Merrill Lynch’s chief U.S. investment strategist, Richard Bernstein, cut his recommended stock allocation from 50 percent to 45 percent. Bernstein said that the equity markets looked too speculative. He went on to say that the current froth in the market is more indicative of the end of a market cycle than for a new bull market.
Techs were hardest hit. Many companies such as Motorola and AOL Time Warner fell as much as 10 percent. Tech stocks were hemorrhaging across the board from networking, software, chips, and telecomm to Internet shares. Precious metals and energy stocks were today’s big winners with the price of gold back over $321. Silver prices also jumped $0.11 to $4.552.
Despite earnings warnings today, analysts are still forecasting pro forma profit growth of 15 percent this quarter. These numbers aren’t real, but heck, who pays attention to truth anymore? For a picture of real earnings please see last week’s Wednesday Wrap Up.
Volume came in at 1.44 billion shares on the NYSE and 1.63 billion on the NASDAQ. Market breadth was negative by 19-12 on the NYSE and by 22-10 on the NASDAQ. The VIX rose 1.71 to 31.76 and the VXN by 1.83 to 51.99.