Weekday Commentary from Jim Puplava
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Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
Wednesday's Stock Market WrapUp
A Question of Beliefs
There was a time not too long ago when the world seemed much simpler. The economy was booming, the stock market went up each year and the talk was of the new era of wealth creation in the US. The old models of stock market valuation and economic paradigms were thrown out the window. This time it was different. We had begun an era of unlimited prosperity. Rapid technological change was transporting us into the 21st century, so you had to think differently. Knowledge was expanding exponentially and our enlightened leaders in Washington and Wall Street were blazing new trails. The Fed had tamed the business cycle so recessions were a thing of the past. There would be no more economic pain. Monetary policy had advanced to such a stage that recessions and bear markets would be relegated to an anachronism in the economic history books. American corporations had undergone such a transformational change in efficiency that they had morphed themselves into perpetual profit machines of wealth creation for shareholders.
The world stood in awe of America’s economic transformation. Our economy was adding new jobs, economic growth continued to expand at accelerating rates and our stock market continued to turn ordinary people into millionaires. In late 1999 President Clinton lectured the heads of foreign governments at a G-7 meeting about the ways and wonders of America’s new economic paradigm. Our robust financial markets seemed to confirm and only reinforce this view. The year 1999 would be the fifth consecutive year of 20 percent gains for the stock market. In fact, the Nasdaq would rise over 70 percent that year reflecting the miracle earnings and performance of technology companies.
These were indeed prosperous times. The ability to create wealth had become so pervasive that ordinary investors no longer needed advisors. It was now possible to day trade your way to prosperity. Financial advertisements featured day trading investors helping out countries, buying yachts, visiting their islands, and high schollers becoming millionaires through trading the markets. During this time many professionals from doctors to attorneys gave up their profession to take up careers as professional traders. Why work when you could make three times the wealth with just a few trades a day? All you needed was a few good IPO and you were on easy street. If you didn’t have the time to day trade, you simply bought an index fund which would generate annual returns of 20 percent a year. Making money in the financial markets was considered so easy that even the financial media found they no longer needed the experts. Many of them wrote books that divulged their general wisdom for making money in the markets.
So much for storytelling and fantasies. The five-year mania in the stock market came to an end in March of 2000. Initially when the markets began to crack during the first quarter of 2000, financial experts told us that this was a mere correction. By the second half of the year, the markets would resume their upward trend. It didn’t happen. Instead of double-digit gains, investors experienced double-digit losses. By 2001 investors were told the same story. The forecast for prosperity was off by just a few quarters. The Fed was now on board and there should be no worries about the economy and the financial markets. There would be no recession and there would be no bear market. This was just a normal correction and delay in what was a permanent bull market trend. The Fed easing would take care of any recessionary fears and lower interest rates would make stocks that much more attractive. The second half recovery became the mantra of Wall Street. The best and the brightest economists and analysts had plugged the numbers into their computer models and they all spit out "Recovery!"
Finally, A Scapegoat
By the third quarter, the Fed had been lowering interest rates aggressively. Each time they did there was a momentary rally in the stock market, but those rallies failed to hold. No one acknowledged the fact that we were headed toward recession or that we were even in a bear market. The forecasts still called for 2-3 percent economic growth and new highs for the stock market. The myth of recovery and a resumption of the bull market were shattered after the events of September 11. After 9-11 everyone now had a scapegoat for the inaccuracy of their forecasts. The terrorist attacks on 9-11 gave everyone a way out. It was now okay to say words like “recession” and “bear” market, which were conspicuously absent prior to the events of mid-September. Wall Street blamed the tragedy for their forecasts falling short. Businesses blamed the tragedy for missing their profit estimates. Many firms would now use this as an opportunity to take big bath charges burying goodwill charges-offs and other bloated expense charges as part of the tragedy. Economist could now find an easy way to explain away the reasons for their failed forecasts. The Fed could also cite the tragedy as a reason for why rate cuts had failed to forestall a recession. Everyone now had an alibi.
In the midst of the new crisis the Fed did what it always did when confronted with a crisis, which was to lower interest rates, and inject liquidity into the financial system. By late fall the money supply was growing at double-digit rates. The financial markets responded on cue to the new injections of liquidity. Stocks rose from late October to the end of the year, but not enough to prevent another year of losses for the major averages. The lower interest rates were plugged into the economic models and they spit out the same forecast. The economy would recover along with the stock market. But news from Enron and Global Crossing raised a new issue of trust with investors. What began to unravel was the myth of the new era. Each new week seemed to bring a new accounting scandal. It didn’t end with Enron. A parade of companies were under investigation or began to disclose that their numbers during the miracle years weren’t what they were portrayed to be. New investigations showed culpability rested with not only company officials, but also with the accountants and the analysts.
Truth, Justice & The American Way?
Trust had become the number one issue with investors. Wall Street and corporate America had a credibility problem. The media now had a scandal to report on and evening newscasts became filled with talk of nothing more. While it is easy to focus on the scandals, it takes away the much broader issue of what gave birth them. Certainly greed and human nature are at the top of the list. But if we want to hold corporate America, the accountants, and the analysts accountable, we must also hold government accountable as well. The broader issue of money creation and an explosion of credit are seldom discussed along with the scandals. Yet, it was the decision of the Fed during the end of the first term of the Clinton Administration to flood the markets with money and the strong dollar policy or the Rubin Treasury that is also to blame. Flooding the markets with money brought down interest rates, creating a credit boom never seen before in history. Consumers went on a debt and spending orgy that continues to this day. Corporations did the same. They either borrowed money to buy back stock or to buy other companies. In the process, they overpaid for companies and loaded up their balance sheet with debt. The Fed's easy money policy created the credit boom that flowed through corporate and consumer balance sheets.
The financial markets also participated in inflating the bubble through the securitization of debt. GSEs such as Fannie Mae and Freddie Mack raised billions in the security markets and helped to facilitate the new boom in housing by expanding credit and making it easily available. The deregulation of the financial industry transformed our financial markets. The securitization of assets, derivatives, and new financial products soon replaced the making of goods as a main source of economic growth. In fact many of America’s top industrial giants from GE to GM had morphed themselves into financial entities. All one has to do is to look at the footnotes of GE’s financial statements and where they get the majority of their revenues to come to the conclusion that the company has morphed into a financial conglomerate.
What We Choose to Ignore Will Haunt Us One Day
The point of all of this is that while financial scandals make the front pages, very little time is spent in examining the easy money and credit binge of the 90’s. Nobody in Washington or on Wall Street seems to understand the dangers of this mountain of debt. However, it hasn’t been forgotten in the credit markets. Credit spreads are widening and credit-default swap premiums are rising. This signals that greater credit problems and more Enrons and Global Crossings lie in front of us. The unwinding of the 90’s credit binge has just begun. As this morning's Wall Street Journal article on Credit-swaps indicates, there may be trouble brewing at Sprint, AT&T, AT&T Wireless and Qwest Communications.
Getting back to the issue of accountability, I direct your attention to Washington. Within the display of grandstanding and pompous indignation, it is forgotten that both sides are guilty of malfeasance. These scandals took place during the 1990’s under the watch of both parties. One party controlled Congress and the other party controlled the White House. I understand that this is an election year and both sides are looking for a political issue to run on. However it is disingenuous for one party to blame the scandals on the other. It is demagoguery in its highest form and smacks of hypocrisy as well. Democrats are now calling for Cheney to give back his capital gains for selling Halliburton on which he paid capital gains taxes. When he took office Democrats insisted that he sell his stock now they criticize him for selling it. When a public official takes high office they are required to either sell or put their assets in a blind trust so as to avoid conflicts of interest. Cheney sold his stock. Nothing is said about the capital gains of Robert Rubin, John Corzine, Terry McAuliffe, or Tom Daschle's wife getting paid by John Doer to lobby against stock options, which were conveniently dropped from the Senate Reform Bill.
While the country is suffering from a debt and spending binge and the issue of trust has become paramount for the financial markets, Washington could go a long way in restoring confidence by stopping the demagoguery and the hypocrisy, which has become so widespread. The media has a role to play here as well. They should call Daschle or Corzine to answer on their lobbying efforts. Today the Washington Times did a story on Corizine’s firm Goldman Sachs that ties the firm to stock schemes of inflating stock prices the 90’s boom. So instead of serious discussions as to what really ails the economy and markets, we instead are treated to large doses of hypocrisy. It is no wonder the investor is losing confidence in the markets. The issue of trust and accountability applies to Washington as well as Wall Street. We are shortly to get a dose of that reality when the government releases its economic numbers for the years 1999-2001. Like the corporate books, which took liberty in how the financial numbers were presented to shareholders, we will find it is the same with the government’s books.
I’m reminded of something I wrote back in January of 2000 in Planes, Trains & Dot Coms Revisited ” When this cycle comes to an end, many questions will need to be answered. How could stock prices rise, so fast? How could investors have been so willing to pay so much for what they knew so little about? Our leaders will need a scapegoat—who will it be? Will it be Wall Street or Washington? Whose face will they put on the tragedy…The new era accolades will be replaced by the sarcasm of hindsight. The hubris of the media will change to exaggerated calls for reform and regulation…The era will have its villains and heroes. We’ll remember the millionaires and the billionaires, as well as the rogues and the traders. In the end we will ask ourselves how we could have been so easily mislead. Was it the technology that mesmerized us or was it the fascination with wealth…While Washington and Washington will look for answers to explain today’s technology stock market bubble, they need look no further than human nature itself. The stage and the props may change, but the actors are the same—man himself.”
Today's Markets
The rise in the major indexes reversed nearly seven consecutive days of declines. Investors are hoping that last week's selloff represents the capitulation phase of selling and that a rally is a head of us. Markets never do what they are predicted to do. So when everyone is calling for a capitulation as a sign of the markets' near-term bottom, it is unlikely to occur. There are plenty of technical indicators that signify a short-term oversold condition in the markets. These indicators would seem to imply that a bear market rally should be forthcoming.
But this is turning out to be no ordinary bear market. Hype, intervention, and complacency is preventing a normal course of action. The Fed talks of intervention; while Washington calls for more regulation. The times are uncertain and made more so by the political bickering in Washington and the hyperbole coming out of Wall Street. In the Middle East, two bombs exploded in Tel Aviv. Just when you thought you might get another breather, new headlines appear. Today it was IBM’s earnings, which fell short of estimates, another scandal involving John Corzine’s Goldman Sachs, and bombs in the Middle East. The news caused investors to vacillate all day with the markets going from losses to gains. Buyers showed up in the technology arena hoping to play a summer bounce. Clearly the news from tech stocks point to more problems ahead with no recovery in sight. In Washington, Greenspan laid the blame of faltering markets on corporations. The Fed Chairman tried to distance himself and his own policies at the Fed as part of the problem. Apparently nobody in Washington or Wall Street sees any problem with oceans of credit flooding the economy. The fact that debt and credit have replaced savings in the U.S. is glossed over.
Despite all of these difficulties, investors and analysts still remain optimistic that there will be another rally or temporary relief in the markets. Technicians lament that there have been no follow thorough rallies other than a few brief spurts in stock prices. However, volume is picking up and that is always a sign that something is about to change. Heavy volume on down days is indicative of the often referred to capitulation theory just as heavy volume on up days is a sign of buyers coming back into the market. Volume on the NYSE today was 1.92 billion shares and 2.32 billion on the Nasdaq. Market breath was positive by 18-14 on the big board and 19-15 on the Nasdaq.
The news was good or bad depending on how it was spun. IBM and JP Morgan beat estimates. That was the good news, but their profits were down. As pointed out in earlier Market WrapUps, estimates have been lowered so much now that most companies should be able to exceed them. Perhaps a string of companies beating estimates while real earnings fall, should be enough to give the market that summer rally. However, it should be pointed out the longer we go without a significant rally occurring, then the less likely it is to happen. If the market continues to sell off without a short-term reversal in trends, then that will indicate that the second phase of this bear market has begun and it is time to put your life jackets on because the full force of the storms will be upon us.
Bond Market
The treasury markets moved very little today in choppy trading. The 10-year note was up 3/32nds to yield 4.68; while the 30-year bond rose the same with the yield dipping slightly to 5.44 percent. In economic news today, June Housing starts fell 3.6 percent; while building permits rose 1.4 percent. On the economic docket for tomorrow will be weekly initial employment claims and the leading economic indicator index for the month of June.
Overseas Market
The markets seemed to be in the rally mode across the globe. There was a strong rally throughout Europe with all eight major indexes rallying. Some of those indexes such as the CAC 40 Index rose as much as 3.71 percent. The only weak spot globally on Wednesday was in Asia where the Nikkei rallied while most other markets fell.
© Copyright Jim Puplava, July 17, 2002