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Posted 9/22/2003
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We cannot speculate our way to prosperity
Soaring margin debt. $100 million paydays. Dead-fish analysts cheering no-earnings techs. All signs that the mania that made the bubble is alive and well.
By Bill Fleckenstein
Reflecting on the recent news out of Wall Street, I have been struck by the way current psychology and behavior resembles the frenzied days of market mania at the end of the last decade.
That folks have chosen to live in a time warp seems particularly clear from the report that margin debt at National Association of Securities Dealers-member firms climbed to $27.977 billion as of this past July. To put that number in perspective, it was only $21.403 billion in March 2000 and about $6.481 billion at the beginning of 2003. At the New York Stock Exchange, margin debt as of last July stood at about $148 billion, down from a record $278 billion in March 2000 (though up from $130 billion in September 2002). This hefty debt increase by non-NYSE firms indicates to me the clear evidence of speculation, as smaller firms heavily leverage up.
Turbocharged trio of tickers
In the past several weeks, more telltale signs of speculation have also appeared in small-cap land. (To my friends who operate in this arena, a thanks for passing on the observation.) A week ago Monday, for example, Blue Coat Systems (BCSI, news, msgs) was up nearly 10% to $10. Friday, it was trading above $12. This former high-flier (formerly known as CacheFlow) is down from about $100 a share, having changed hands for just $5 about a month ago. Or, consider the case of one-time mania darling Covad Communications (COVD, news, msgs). After having commanded all of $2 a month ago, the shares were up better than 10% last Monday and now trade at around $6. To round out my little trifecta of speculative puppies, Transmeta (TMTA, news, msgs) closed up at $2.46 that Monday, for a gain of more than 28%. It's now above $3. A few weeks ago, it traded around $1.50.
The Wall Street landscape further resembles late 1999 or early 2000 when viewed through the actions of the dead-fish community. Its members are busy raising price targets as soon as a price target has been hit, irrespective of whether the company in question can achieve earnings commensurate with the given valuation, let alone a bar set even higher. Many sought-after companies with virtually no earnings are judged by their "robust" "metrics" -- appropriate for the "space" they are in. These quintessential mania stocks remain unfettered by the need to produce earnings. What earnings they have shown have been overstated, thanks to stock options, continual one-off charges and pro-forma earnings counted before bad stuff. Nevertheless, in spite of these minor details, folks still pay silly prices for very little in the way of earnings-per-share or growth of same.
Propagating illusion to keep prices aloft
Naturally, this behavior is commonplace in tech land. To encourage folks to keep it up, companies are back to issuing raised guidance, though for most of them, we're only talking about pennies a share. But that supports stock prices in the teens, 20s, 30s, and 40s, meaning that many of these stocks, though down a lot from the peak, are still just as crazy as they ever were when viewed through traditional measures of valuation. Insiders, I would just add, are still selling stock in record amounts, whether you want to count it on a per-share basis or a dollar-weighted basis. Meanwhile, the Fed has its pom-poms in hand, cheering enthusiastically about productivity whenever it can (while printing money as fast as it can).
Of course, the scandals of the last few years have demonstrated that corporate America is less than trustworthy. Many of the abuses have been addressed, but not all. Now we learn that not only did Wall Street analysts behave questionably, certain mutual funds may have, as well. While rounding up mania-like behavior, I would be remiss in failing to note that the (now former) NYSE chairman was slated to make something on the order of a couple of hundred million dollars before the flap that forced his resignation broke out.
Statistics to strip bare the bullish case
Meantime, as folks try to convince themselves that we have magically been transported back in time to the mania, evidence to the contrary has been piling up at the macro level. The dollar has seen one of its biggest drops in the last 20 years, greater than in 1987. Debt levels are the highest they have ever been, with the debt-to-GDP ratio now about 350%. One of the largest collapses ever occurred recently in the bond market. Homeowners who have levered up now face the prospect of depreciating home values. Our budget and trade deficits are just staggering.
Further, many state and local municipalities are in a state of total disarray, with small places on the West Coast such as California being the most noticeable, but not the only, examples. Jobs, of course, continue to be eliminated, not created -- a fact that seems to have escaped Brian Wesbury of Griffin, Kubik, Stephens & Thompson (the economic equivalent of a dead fish), who on the op-ed page of last Monday's Wall Street Journal opined unequivocally, and without support: "Virtually every sector of the economy is booming today, especially high tech. . . . Weak job growth is an anomaly and cannot last."
Of course, there is also the problem in Iraq. We can try to be optimistic and conclude that our presence there, while expensive in the short run, may be beneficial in the long run. I'll just grant that point to the bulls, even though the reality may be more problematic. I am willing to be hopeful on that score.
The good, the bad, the undiscounted
When you put a summation sign in front of the behavior and problems previously described, the risk/reward equation is completely and totally out of whack. To me, what it boils down to is the famous passage from Clint Eastwood's "Dirty Harry": "The question you have to ask yourself is, 'Do I feel lucky today?'"
That is not meant as an in-your-face comment. My purpose is to set folks' complacency and risk-taking in stark relief to the manifold problems that remain undiscounted via lower prices.
When I gave a speech titled "Bubblenomics" in the fall of 2000 (as discussed in one of my columns; click here), it struck some people as just another negative piece about what was happening. But after the bubble burst, I received many e-mails with a common theme: "Gosh, I sure wish I had read the speech beforehand." In many of those cases, my thought was, if you had read it, would you have done anything differently?
On the horns of a dilemma
Speaking of e-mail, I would like to share a question from a reader, as it echoes what I've been hearing from many folks. He begins: "I don't disagree with you that it looks like stock prices have gotten far ahead of the underlying value. Here's my situation: I lost a lot of money in the crash of the last few years. Finally, here's a chance to get back some lost money for retirement. I don't want to be bagging groceries at age 70. Interest rates are so low on deposit accounts and CDs that it's hardly worth the effort to complete the application form and hand them the money."
He continues: "Stocks are up huge this year. Because of the way my 401(k) is arranged, I can't buy individual stocks, or short the market, or play the options game. I can only buy mutual funds. Is there some happy medium between taking the risk of stock ownership and getting a meaningful return on investment? I wish you'd address this issue for the small guy (like me) in one of your articles, instead of writing about the euro, or other things that I can't invest in one way or another."
First of all, I think it's worth pointing out that Mr. Market does not know how much money you have lost, doesn't know what your cost basis is in something, doesn't know how old you are and doesn't know what your plans are. To think that the market is "there for you" is often a mistake. It's best to think that the market is there to take your money away from you. If you behave in certain ways and reduce your risk, then you can use the market to make money. But it's the wrong analogy to regard the market as an ATM machine, as so many do. Think of it, instead, as a lion waiting to rip your lungs out.
Thread on how to stitch a better quilt
In any case, I know that employee benefits plans are set up differently. Some impose restrictions on what you can do in a 401(k) (as in this particular case, where individual stocks such as Annaly Mortgage (NLY, news, msgs) cannot be bought for income). So, what folks need to do is figure out how to manage their own 401(k) plan in the context of all their other investments. It's not necessary to replicate every single investment idea in every investment account.
Before offering my thoughts on what should be a part of anyone's holdings (which will come as no surprise to regular readers), let me address this reader's concern regarding "the risk of stock ownership." For the last few months, I have thought that it's way too risky to take on much exposure. That juncture, had one been so inclined, would have been last winter and spring, when the path of least resistance, as I noted, was going to be up for a while. I myself was net long for a brief period. However speculative, that idea worked. But now it is too late.
You cannot allow recent headlines or recent market action to force your hand. That doesn't mean you can't change your mind about something. But you need a reason for doing so, not just, gee, stocks have gone up a bunch. Folks in the same boat as this fellow will have to wait until another opportunity comes along -- either for a moment in time when a bear-market rally might set itself up (as we saw last winter or spring), or for the ultimate washout of the bear market, when stocks will be dirt-cheap.
Tuning out the hype
In the meantime, folks should focus on preserving their capital, which means owning short-dated Treasurys. Further, they need to protect themselves against the printing presses being unleashed by the Fed and other central banks. Whether through their 401(k), via a precious-metals mutual fund, or through their own account, via mining stocks or the metals themselves, they need to purchase that insurance.
Though I have not talked about precious-metals mutual funds, a good one is the Tocqueville Gold Fund (TGLDX), run by John Hathaway, someone I know and respect. Perhaps that is something to consider for one's 401(k). Meanwhile, for those folks considering the metals or metals stocks, a word of caution: With prices obviously up somewhat, you have to work your way into a position, rather than establishing it all at once. Nevertheless, I continue to believe that precious metals are headed much higher. I hope that folks consider them for their portfolios, as landmines of risk continue to dot the investment landscape.
For 'The Market Rap,' a new home-sweet-home page
Finally, I would like to share the news that beginning Monday, Oct. 1, my daily column, "The Market Rap," will be relocating from RealMoney.com to my own Web site, Fleckensteincapital.com (requires subscription). Readers can go there for more details.
Bill Fleckenstein is 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 the time of publication, Bill Fleckenstein was long the following equities mentioned in this column: Annaly Mortgage. His investment 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.
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