October 7, 2002 -- 9:15 AM
Doomsayer Paradise Found
Part of Wall Street’s job is to ensure that retail clients do not acquire the confidence to go it alone. After all, Wall Street’s ‘expert’ services are tailored for the unseasoned, not the skilled small investor: how else could Wall Street peddle ‘diversified’, ‘professionally managed’ investment products if it were not for its promotion of the teacher/student relationship?
That said, some people would argue that Wall Street should be in the business of making money for all of their clients, big or small, because this would ultimately help firms maintain long-term relationships (and profits). Quite frankly, making money for clients is not the point – taking money from them is.
A big part of the Federal Reserve Boards job is to ensure that the financial system does not encounter bottlenecks. Supposedly uninterested in the day-to-day fluctuations in stock prices, the Fed serves to reduce or increase the amount of money in the economy and adjust the interest rate by which banks borrow money. The Fed also attempts to control the ‘free’ market price of their brand of money along with other currencies – yet it is debatable whether or not the Fed directly manipulates stock prices.
Wall Street & The Fed During Crashes
When combined, Wall Street and the Federal Reserve Board make a formidable team. On the one hand, every time an investor becomes fearful and wants to sell it is the job of a Wall Street broker to soothe these apprehensions and keep the investor in the game. On the other hand, whenever liquidity bottlenecks arrive it is the Fed’s job to open the window and/or change the lending rules (if necessary) to keep the wheels turning.
Nevertheless, during volatile market phases, even as Wall Street aims to cool investor jitters and the Fed acts to heat up exchanges of capital, dangers still lurk. Such is why the rest of October could be interesting
The Week Ahead
Some of the main reports due out at the end of this week are producer prices, retail sales, and preliminary consumer confidence for October (Mich.). While September retail sales are expected to show a decline which could stifle recovery hopes further, the confidence data is forward looking and could be given more investor attention.
Steadfast bears can be heard loud and clear: ‘its now or never!’ To be sure, if the markets are going to crash they will likely do so within the next 3 weeks. Quite frankly, the case for a crash is being splashed across newspapers around the globe: profits are anemic, the consumer led ‘recovery’ is fading, and global financial markets are falling. Indeed, it is a doomsayers paradise given that last weeks ‘neutral’ jobs report couldn’t stop the bleeding.
That said, after October what may quickly be ingrained within the markets subconscious is that 2002 is write-off, and this could help price simply meander rather than plunge further. Yes, I realize this is seasonal speculation and things could get better or worse independently of what month it is. Nevertheless, the markets do not tend to go straight down, and many investors will be breathing easier once October ends and/or the relief rally begins. As such, a relief rally, however brief, soon looms – the only question being from what level the rally begins.
Paradise Lost
After 6-weeks of stock market losses the volatility numbers are still forecasting the potential for a complete stock market meltdown. Quite frankly, investor fear, as tracked by the VIX, has not been this strong this long ever before.
Accordingly, market watchers are keeping a close eye on Wall Street and the Federal Reserve Board, for two reasons:
1) If prices continue to falter the Fed will soon initiate an intermeeting rate reduction – a largely symbolic yet potentially effective method of stabilizing the markets.
2) Wall Street will eventually, with or without the Fed’s help, begin to throw cash at the market. They will do this either to try and force short sellers into covering or because they actually believe the markets are a good investment. Those that believe because of some derivatives induced implosion that Wall Street will flea the financial markets must consider the Fed -- which will, if need be, give firms the money to throw at crashing stocks.
Granted, no one knows the exact price levels required for the Fed to take action or for firms to leverage up in stocks. Nevertheless, rest assured that the Dow will not fold to 5,000 without some heavy resistance.
This brings us back to the ‘unseasoned’ investor. Quite frankly, unless the average investor is growing senile, they will undoubtedly remember that previous attempts by the Fed and Wall Street to stop the markets from falling have failed. As such, another Fed engineered market recovery similar to 9/11 is unlikely to transpire, as is another Wall Street led rally like the one that took place in March 2002, or when the Street relentless heralded that every economic statistic was supposedly proof positive that another great expansion was well underway. Rather, the markets are likely to remain more closely hinged to corporate profits and economic developments -- the markets, despite small relief rallies and mini crashes, are likely to remain more honest.
As the markets lead into what could certainly become a gruesome week this point is well worth remembering. Why? Because each time the Fed, Wall Street, and even corporate America for that matter (buybacks) act to brace this market their efforts become a little less effective – investors become a little less gullible.
Going forward: Volatility is guaranteed, new lows are almost certain, and a sharp rebound in prices is highly possible (essentially guaranteed after a severe decline). Whether or not Wall Street and the Fed are villains or hero’s come this Halloween is the interesting question.
Reality Lost
Wall Street’s Abby Joseph Cohen appeared on Wall $treet Week on last Friday. Below are some quotes and comments from the transcript:
Abby: “for most Americans, fortunately, their individual portfolios have been reasonably well diversified. And that has been very helpful because stock prices have gone lower, bond prices have risen notably.”
What should have been asked: What about those Americans who listened to you Abby?
Abby: “I’m amused always by the way I get portrayed. It was in 1999 and early 2000 that I was criticized for not being bullish enough and, in fact, in March of 2000 when I suggested to our clients that they sell some stocks and be especially careful about technology stocks, I was blamed for substantial decline in the Nasdaq.”
‘not being bullish enough’ -- what should have been asked: What color is the sky in your world Abby?
Fact: In March 2000 Abby lowered her equity weighting from a ridiculous 70% to 65%. She never cut her market targets and never stopped saying the market was undervalued for the entire year, even as corporate earnings estimates were dramatically cut. Her vague, and might I say extremely embellished anti-‘tech’ comments sent to clients, were not voiced during her ‘severely undervalued’ media campaign.
“Our estimated 'fair value' level of the [Standard & Poor's 500] at year-end 2000 has been 1575 since the beginning of the year. To date, we see no compelling reason to adjust the model inputs." Abby – Oct 13, 2000.
Gibbs: “Do you think Wall Street owes anybody? I’m talking the big picture. Wall Street owe any of the individual investors an apology?
Abby: I don’t think that’s an appropriate question.
Unless Abby’s twin sister has been filling in for Abby while she has been in a coma for the last 28 months… THIS IS THE ONLY APPROPRIATE QUESTION!
Abby: “There really seems to be an unusual risk aversion. That is, not only are investors avoiding risk, but so too are decision makers within corporations. Many people are concerned about the others looking over their shoulders.
So for example, institutional money managers are concerned that if they buy stocks -- even if they think those stocks are very attractively priced -- that if the stocks don’t rise in value, in price, sometime soon that they’ll be looked at askance by their shareholders. We see they same sort of problem in corporate America, where corporate decision makers are worried about committing capital to new investment projects or even to hiring new workers unless they can be certain of success in a project. And of course, that kind of certainty is not possible.”
To reiterate (read closely):
“Corporate decision makers are worried about committing capital to new investment projects or even to hiring new workers unless they can be certain of success in a project. And of course, that kind of certainty is not possible.”
Finally the truth comes out. Abby doesn’t have a clue. With capacity utilization rates at near record lows, profits in the gutter, and consumers beginning to moderate their spending habits this is not the time for businesses to throw common sense to the wind. ‘New projects’ must be undertaken to either meet demand or increase profitability. To even insinuate that it is ‘unusual’ that corporations are unwilling to undertake new capital investment projects and that this is a ‘problem’ is buffoonish.
Suffice it to say, what continually bothers me about Abby’s opinions is not that they have been wrong, they have, but that she always blames someone else for her faulty crystal ball. Kudlow and Cramer have both admitted that they suffered from delusions in the late 1990s -- they have learned from their mistakes and are trying, save what I believe to be Kudlow’s sometimes ridiculous comments about the Fed, to move on. Why doesn’t Abby?
Abby: “some companies right now know that shareholders are looking at free-cash flow. And one way to manipulate that number is to dramatically reduce capital spending. If a company has offset their capital spending and has deferred it indefinitely, that’s not a very good sign for long-term growth.”
Think about what Abby is saying here: companies are ‘haphazardly raising free crash to appease investors’? This simply doesn’t make sense. If sales were strong and there was a need to expand companies would be announcing, quite joyously I might add, ‘we are undertaking new capital spending initiatives to keep up with demand!’
To be blunt, the above statement by Abby, unrehearsed as it may be, is a moronic comment that comes from an extremely twisted mind. There is no precedent for someone remotely intelligent actually believing that a company not willing to lose money with risky capex spending is making a long term mistake by generating free cash. Maybe Microsoft should use there cash to quickly bring out Window XP 2003? Perhaps Intel should blow the farm on creating a 4 Gig chip? Maybe GM should spend billions on mass producing hydrogen cars? Anyone who believes this is not only wrong, but foolish.
Decoding Abby’s Faults
When a single U.S. consumers begins to save money and get out debt this is great news for the individual but terrifically bad news for the economy. The same holds true with individual companies: when a company looks to generate cash, possibly by delaying unneeded expansion plans, this makes the company stronger – this is especially the case when demand is in decline and no signals of a turnaround are present.
Those that choose to blame the pitiful state of the macro economy on individual companies is living in a fantasy world. What is good for Abby is not good for corporate America.
Abby: “we think that investors will gradually come back to the marketplace.”
There is no need to attack this statement. It speaks for itself. And yes, it has been spoken many times by the ever optimistic Abby Joseph Cohen.
What Abby, like many investors, needs to recognize is that only two things can save the markets right now: The Federal Reserve Board and Wall Street. We are in a doomsayers paradise - an environment in which all rallies are met with skepticism and all declines shake out a few more weak hands. Until there is a crash, or ‘capitulation’ the economy is not safe – corporate America is not safe. And yes, those companies that are able to currently generate free cash will be the strongest companies when the dust settles…
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