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While some would have you believe that intervention in the marketplace is only as sophisticated as a greenback printing press, this is not entirely true. For example, many Americans are either unable or are deterred from rashly panicking and selling their stake in the U.S. markets due to configurations of 401K, pension funds, etc – whereas the banks closed their doors to stop panic in Argentina and Uruguay, in America market ownership by design can help such panics from ever arising. Moreover, and as was the case in late July, even when selling panics do arrive corporate America stands ready to leverage shareholder wealth and buy back shares at a rate in line with the that of mutual fund outflows (roughly $50 billion in both buybacks and outflows in July). Yes, companies are laying off workers, reporting soft profits, and lowering capital expenditure forecasts for 2003…yet if the markets plunge the buybacks will arrive.
Suffice it to say, the U.S. markets are in many ways a rigged game in that domestic capital is not merely invested but embedded in the marketplace, and shareholder wealth is not simply distributed but reinvested whenever share prices falter (thanks to dividends being taxed twice and new buy back laws enacted in 1982). To be sure, these two prominent features of the American markets alone add liquidity to the markets when it is needed most – or during periods of frantic selling (selling from unfettered sources of capital such as foreign investment, mutual funds, private investors, hedge funds, etc.). And yes, during market panics this added liquidity is tallied up along with the mysterious placement of dollars coming off the Fed’s printing press.
In sum, the markets have purposely been made to function in an ‘anti-panic’ manner because of regulatory changes and investor brainwashing: so long as many investors have a job they are going to continue to put a percentage of their money into a retirement plan every month. Thus, the question, and it is an overly simplified question at that, is how many people will continue to have a job?
This optimism aside, the Nikkei just registered a new 19-year low and joined the other major world indices in negative territory on the year -- apparently government manipulation of the financial markets doesn’t work. Moreover, currently U.S. futures are sinking suggesting that previous insights may be coming to pass: ‘upon returning from vacation it may not take traders and investors long to figure out that despite all the excitement the situation (earnings & economy) has deteriorated significantly since July (Aug 21)’. Point being, even though the U.S. financial markets certainly have embedded capital within this is not a quantitative indicator of market strength. Rather, the markets can weaken or strengthen independently to ‘who’ or ‘what’ is holding a stake in stocks or standing ready to buy --- who or what is buying at any given moment is what matters.The Major Difference Between 1929 and Today
So much material has been written about 1929 that it is difficult to point out any new material. Nevertheless, for most people the chart below will suffice.
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Although similar to modern day mutual funds the investment trusts of the 1920s did not become a huge success until moments before the markets collapsed in 1929. In fact, flows into investment trusts in the first 8 months of 1929 almost doubled the entire 5 years proceeding. Point being, when the crash came in October 1929 most investment trust holders suffered immediate losses.
That many new investors joined the ‘speculative orgy’ moments before the markets reached climax is telling of two interrelated things:
1) Those who lost money without first making money did not develop a ‘gambler’s fallacy’ type syndrome. More simply, they did not perpetually believe that losses simply meant profits were that much closer because they never had the experience of making profits.
2) They were unwilling to invest more money. Most people are skeptical when first buying stocks. It is only after a profit is made that investors tend to take on a ‘I am a genius’ attitude.
Structure and Psychology
Everyone joined the party right before the roof collapsed in 1929, and when the roof did collapse no one could make it to the exits: confirmation of trades took hours if not days, and panic was allowed to fester even as J.P. Morgan swung into action (JPM announced equity purchases of stocks and offered words of encouragement in Oct 1929).
Today: By contrast, investors have joined the markets steadily for the last decade, and when the roof begins to collapse everyone sees the exits but concludes that the roof will hold. The Fed need not swing into action very often because panic is controlled by both the methodical rate of decline and the fact that many have contracted the gambler’s fallacy syndrome (studies have shown that gambler’s believe they have better odds of winning each time after they lose).
September/October = Meltdown?
Until earnings warnings season is over (second week of October) the markets are not safe. Moreover, until consumers gain confidence the U.S. economy will continue to post barely growing results or worse. Such are the themes heading into what is historically the worst month for stocks: earnings and confidence, or should I say lack thereof.
The primary reason why it has become almost ‘popular’ to assume that the markets will drop in Sept/Oct is because talk of a retest of July’s lows has not vanished since the latest rally began. To be sure, lighting up the front page of CBS MarketWatch over the weekend was the phrase ‘markets may retest July lows’, and similar sentiments have been voiced by many professionals around the web. Suffice it to say, once market participants begin to believe that an investment opportunity will not present itself until the markets retrace/retest their previous lows the action becomes self-fulfilling.
One of the reasons why the word ‘retest’ is sticking in the investor’s mind is because the August rally was on light volume. Moreover, those in tune with the record high short selling levels as of Aug 12 would also conclude that light volume with possible short covering contained within is not a framework for a sustainable market rally. The other reasons are fundamental and basic: earnings estimates are in decline and the consumer spending outlook, save those people refinancing their homes for the 13th time, is murky at best. At worst, it will not be a pleasant Christmas spending season and 2002 will be regarded as a write-off come late October...
Speaking of write-offs. Remember last year’s 3Q02 earnings results? The results which uncertified CEOs and CFOs packed in every ounce of negativity because the markets were dropping and investors expected a ‘wash out’ reporting season? Well, and Mr. Hill will be updating his column later today, when the trimming is all said and done 3Q02 results may only beat 3Q01 results by 4%-6%. This stat alone is telling of exactly how weak corporate profits are today and why the markets are deservedly weak as well.
Conclusions
Getting back to the question of paramount importance: how many people will continue to have a job? Friday’s employment report will shed some light on the matter (currently a 6 handle on unemployment is expected along with 50K in payrolls). Also of importance this week is the August ISM Index (Man today and Services on Thursday) and July factory orders.
Knowing that the outlook for the markets is not appealing, who is left to buy? Once you figure out ‘who’ was buying in August you may be able to answer this question. Quite frankly, beyond corporate buybacks and short covering there is no buying leadership. And while the roof may not completely collapse, and liquidity won’t completely dry up, you can see people milling around the exit signs.
Time To Cover?
Since selecting UST for the Wish List (July 22) its share price has appreciated dramatically, and well beyond our near term expectations. Although we do not feel the company is extremely overvalued at current levels it is at risk of a pull back. Accordingly, and considering that our initial ‘tentative sell target’ was $35, consider the options below.
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The most obvious opportunity would appear to be the January 35s. However, UST may encounter troubles and/or be worthy of a sell prior to January - this duration carries with it added risk. By contrast, the Oct 35s may be worth considering. We would look to sell UST at $35+ simply because of the size of the rally since July’s lows (30+%) and the near term court risks (there should be 1 more Conwood copycat case more filed).
* We do not track covered calls in the Wish List.
Consolidated Freightways Corp has, unsurprisingly, filed for bankruptcy. Consolidated was highlighted as ‘financially weak’ in the December 2001 Wish List report.
As for our favorite trucking company with the cleanest balance sheet in the business, Heartland Express, the company continues to perform well but we feel it is overvalued given the risks associated in the marketplace (valuation concerns) and economy (its major customer is Sears).
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