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Posted 5/27/2002
Contrarian Chronicles
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The S&P earns a B.S. with a degree mill
A night school earns a spot in the 500, and Sir John Templeton, an investing titan, suggests that now would be a very nice time to short some of those American stocks.
By Bill Fleckenstein
A company in the business of conferring higher-ed degrees just graduated to the S&P 500 ($INX). But judging from its price, Dont Overpay for Stocks was not in the curriculum. That, plus the bears-eye view from Sir John Templeton, as Contrarian Chronicles commences.
When WorldCom (WCOM, news, msgs) received its walking papers from the S&P 500 recently, a company called Apollo Group (APOL, news, msgs) was tapped to fill the empty slot.
The amusing implications of this shift were not lost on a reader, who opined, "That a major telecom company is replaced by a night school 'degree mill' is too funny for words. I don't know which company is worse."
He went on to note that Apollo also bought the College for Financial Planning a few years ago, which hands out the CFP designations that all financial planners must have. In any case, what I think this illustrates is how absurd an index the S&P 500 has become, especially when one considers that whether one likes the idea of Apollo or not, it sells at about eight times revenues and about 48 times next year's estimates. The S&P 500 is certainly not an index that I'd want any of my money tied to for the next few years.
Work out in the 'wait' room, Templeton says
A titan of the investment world, Sir John Templeton, is most emphatically not directing his assets in that direction. In an interview on Bubblevision this past week, he said, according to a transcript passed along by a friend, "Share prices in America are selling at almost double what has been normal in the past in relation to dividends, in relation to earnings, in relation to other indications of value. So, American share prices are much too high." He opined that one should buy bonds and wait for the price of stocks to become more reasonable.
Then he went on to say, incredible as it may seem, "If you own some American stocks, you should balance it out, but at the same time, being short some American stocks." Now, I realize the English there isn't perfect, but this is the transcription of his comments, and grammar aside, the point is rather shocking: He advocates shorting stocks to balance the risk in stocks one might own. To which, I would add only that shorting is very, very dangerous and very, very difficult. You really, really have to know what you're doing. I don't think this is a license to go out and short, but rather a measure of how negative he is on the U.S. market and on markets in general.
Next, it was on to his thoughts about technology. About 18 months ago, Sir John opined that the tech boom was "the greatest financial insanity to ever enter any nation." When asked what had changed since then, he replied, "Very little." He suggested that tech stocks weren't as insane as they used to be, and he wouldn't short them, but they aren't bargains. Here, I would just like to add that many of them are spectacular shorts, and I am short them. But he's Sir John and I'm not.
Lastly, on a subject I have discussed many times -- the need to consider and prepare for the possibility of a 1929 or Japanese experience here -- he said, "For example, the greatest insanity up until two years ago in America was 1929. It was 17 years before the industrial average got back to where it had been in 1929. Now I don't predict that this one's going to take that long. The collapse that started two years ago is probably not over."
He added that he didn't think the Dow "is going to go down two-thirds to about 4,000, but you can't rule it out. That did happen in Japan, and it did happen in America after 1929. So the chances are, the odds are that we're nowhere near the end of the bear market in America." Then, he summed up: "At present, more than at any time in my 89 years of lifetime, I would have a smaller fraction in stocks -- smaller fraction of my total assets than ever before."
Lowering the boom on the boom
Regrettably, that is a message likely to fall on ears stuffed with cotton-candy-ball denial. According to a recent New York Times article titled "Despite a Year of Upheavals, Economic Optimism Is High," lots of people are going to be throwing their money in that direction. It notes: "About 90% of investors say the stock market will increase over the next 12 months, up from 64% in 1989, according to a survey by the Yale School of Management. The level has remained almost unchanged since early 2001, even as the markets dropped." I would just point out that such overwhelming bullishness is not exactly a recipe for attaining a market bottom.
If such an optimistic view were going to be our eventual outcome -- i.e., we were about to have a boom, that the recession was short, mild and over, that the stock market was going to be fine -- I absolutely guarantee you the psychology right now would be horrible. People would be convinced that neither the economy nor the stock market was ever coming back -- witness the low percentage of people who were optimistic in 1975, shortly after the 1973-1974 recession. So, the mere fact that people are so sanguine and so sure about how good things are going to be almost guarantees by itself that that cannot possibly be the case. That's how markets work.
Richard Russell and my friend Fred Hickey are certainly well-versed on that score, and I'd like to thank them for bringing to my attention a news item from a recent issue of Barron's that debunks the theory that a bottom occurred after Sept. 11. (I don't refer to this publication much anymore, since it has become so watered-down, except for Alan Abelson's column.) The story is actually a lengthy, somewhat technical ad by the Market Technicians Association called "MTA Charles H. Dow Award: Identifying Bear Market Bottoms and New Bull Markets." In it, writer Paul Desmond does a good job of chronicling the history of what tends to occur at market bottoms, and the information he has tracked does not indicate that Sept. 11 was the end to this bear market. He points out: "But, as strange as it may seem, the selling during that decline (referring to post-Sept. 11) never reached the panic proportions found near almost all major bear market bottoms in the past 69 years."
I agree. Many people have operated as though Sept. 11 was the low for the bear market, but as regular readers know, I never believed this to be true. I think when those lows are violated, there will be a veritable avalanche as people attempt to get out. When that will occur is not knowable, but I feel certain it will happen. Readers should be aware of this and have a game plan for what to do should stocks begin to slide again in the second half, as I expect they will. That will protect them from the ugly surprise that awaits the unprepared.
De-value investing
By now, regular readers of the Contrarian Chronicles know that in my opinion, protection may lie in the area I refer to in my daily column as "Away from stocks." It is here that the real action is taking place. Most of the time, nothing too earth-shaking is coalescing, but now seems to be the exception to the rule, and that's why it's important to redirect our focus here. I have long been of the opinion that at some point, the dollar was going to come under a great deal of pressure, and this reality doesn't seem to be debatable right now. At the same time, the metals are going up, which in my opinion corroborates the view that we have a currency problem. I don't believe gold is rising because people fear inflation, although I do believe that inflation is always higher than the government reports. Parenthetically, I would say that long term, we will have an inflation problem in this country, but first we're going to have a problem with asset prices getting hammered.
So, the precious metals and other currencies are signaling, I believe, that the trend has changed for the dollar. When you couple this with the weak fixed-income market, you now have a very lethal mix that is a recipe for disaster in stock land. Those three stars, if you will, don't line up very often, but when they do, it is one of the things that could definitely precipitate a stock market crash. They converged in 1987, as well in 1998 and a few other times, though the meeting was very transitory. This, to me, feels like something far bigger and far more powerful.
As the dollar comes under pressure, the Fed could be forced to stabilize it by raising rates at a point in time when the economy is already weak. Obviously, that would spell real trouble. Now, I don't happen to think this particular group of lunatics at the Fed would take such action very quickly, which means the problem will only deepen and therefore become that much more intractable when they finally try to solve it.
Tune out opportunism
Meanwhile, I would like to point out that as people recognize the dollar's problem, there will soon be no shortage of strategists saying, "Okay, buy this group of stocks and that group of stocks to participate in dollar weakness." While a weak dollar does help certain industries compete better on price, it won't be enough to offset the compression that's coming in P/E ratios. So, don't fall for that simple analysis. Perhaps if stocks were dirt-cheap, it might work, but with multiples where they are, this strategy won't work.
The only way to be safe and protect yourself from a declining dollar is to own the euro (or some other currency), gold and silver bullion, or gold and silver equities. The other "plays" will be just that, merely momentary speculations. That said, for people who do not have positions in the metals, I might point out that a lot of these stocks have seen huge runs and are very overextended, so one might want to be somewhat cautious about buying them right now. There are a lot of smaller, tertiary metal stocks that have run up to prices I find quite absurd, and they are now discounting a humongous rally in the price of the metals. Don't get me wrong -- I'm not advocating selling these, and I'm not advocating shorting them. I'm just suggesting that people on the outside looking in should be careful at the moment, if they decide to start buying.
William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At time of publication, Fleckenstein Capital had no positions in the stocks mentioned in this column, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money. While Bill Fleckenstein cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to fleckrap@hotmail.com.
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