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Great(ly reduced) Expectations

Monday, April 28, 2003 | 10:59 AM

Also known as "Not so Great Expectations": After a relatively strong start last week, the markets pulled back on Thursday and Friday. Headline writers blamed poor economic releases, but after the recent run up, profit taking and consolidation is just as likely a culprit.

The key to this period of digestion are pullbacks on light volume, and crucial support levels holding. On the Industrials, that’s the 8100-200 level; My line in the sand on the SPX is 850-60 and on Nasdaq is 1340-50. A breach of these levels would suggest that something more distributive than mere consolidation was occurring.

Meanwhile, the earnings parade continues this week, with companies mostly beating greatly lowered expectations. According to the WSJ, Q1 earnings are up on average 11.7% (329 S&P 500 companies reporting), better than the 8.5% predicted Thomson First Call’s analyst consensus.

As the War recedes from view, SARS is beginning to dominate the wall of worry which the markets have been successfully climbing for now. (Who knows what’s up next when SARS finally fades?). Most of these ungame-able issues have 2 things in common: data points beyond the ken of traditional analysts, and a ready made excuse for CEOs/CFOs to blame their lack of visibility upon.

Their lack of clarity has little to do with those externalities. Rather, we are in an anemic, jobless economic recovery. There’s still no visibility on IT spending increases, mostly because companies do not need any additional Technology. Corporations are still cutting – rather than adding to – head counts. We wonder how a 2nd half recovery can manifests itself sans a rise corporate spending or hiring?

Perhaps too many investors are pinning their hopes on a tax cut – one which is very back-end loaded, and not very likely to stimulate hiring or spending, at least in the short term.

In normal recessions, the resumption of consumer spending is what kick starts a weak economy. This recession, however, the consumer has hardly faltered. Having been made flush via multiple home refinancings, the consumer is more likely in slow their spending than actually increase their already high rate of borrowing and spending.

It’s still way too early to declare this the start of a new Bull market – even if (and that’s a big if) the Bear has been mortally wounded. “It’s the economy, stupid” is more than a mere political slogan; It’s the answer to the question “Where is the market going?”

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Quote: “Patience and perserverance have a magical effect before which difficulties disappear and obstacles vanish. -John Quincy Adams, 1767-1848, 6th U.S. President

Economic Mulligan!

Thursday, April 24, 2003 | 11:12 AM

in Finance | War/Defense

Shanked one, hard left, into the bunker. Awful shot, simply embarrassing. Did anyone see? Does it matter? . . . Do over!

At least, that’s the message Mr. Market has told investors about the economy the past few weeks. What’s that you say? People didn’t shop, firms didn’t hire or buy capital goods during the war? Hey, I have an idea . . . Mulligan!

It now appears that the economy is getting a free pass, as the parade of mixed to poor economic numbers continues (Good GDP, bad Jobs). This raises some very interesting possibilities going forward:

First, the market may now be looking through the economic weakness, caused in some small part by pre-war jitters, and the war itself. If bottoms are made when the economic news is at its worst, than a recovery may be on its way. Hardly empirical evidence, but . . .

Second, there is a silver lining in that corporate earnings have, for the most part, beaten expectations. Yes, these were significantly lowered expectations, and yes, it’s noteworthy that increased cost cutting, rather than better revenues, deserves the credit. But Mr. Market will take good news when it can get it.

That still leaves the $64,000 question: When will corporate spending and hiring resume? A secondary issue remains: Will the consumer maintain their pace of consumption, or are they on the verge of a bout of “buyer’s fatigue”?

Without continued Consumer Spending AND an uptick in Corporate Spending & Hiring, there is no economic recovery. Period.

Which leads us back to where we began – the economy: It has less than 6 months to prove its mettle. How many years in a row can the forsooths erroneously predict a second half recovery? Will we still be hearing the same prattle 5 years from now? I half expect to read the following sentence in April 2008: “We are factoring in an uptick in corporate IT spending in Q4 ‘08”.

If the economic numbers fail to dramatically improve towards Summer’s end, there will be big, big trouble: The double dip theorists will come out in full force; October 03 earnings season threatens to be a fright; This will embolden valuation Bears, and allow Shorts to get more aggressive. This culminates in the Elliot-Wavers confidently predicting (again) the end of the world.

I give this scenario a 30% possibility. If it does play out, I suspect the Bulls will be in for some very nasty selling, as no one will want to hold equities heading into yet another ugly October. Forget the Hamptons, we will be soending this Summer cautiously watching for signs of economic improvement.

As for now, the market is consolidating its gains, and is overbought after the NDX and Nazz hit YTD highs. Expect any under-invested fund managers to put money to work on pullbacks, as we back and fill. As mentioned Monday, the path of least resistance remains upwards – for now.

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Quote: “If you have a garden and a library, you have everything you need.
- Marcus Tullius Cicero, 106 - 43 BC

Crossroads

Monday, April 21, 2003 | 11:05 AM

in Film | Finance

“We meet at a crossroads in history”

Since the strong pre-War rally, the markets have been in a consolidation mode. The back and fill action has had a healthy overall tone to it, with volume lighter on down days. Heavy sellers have disappeared.

Can the Markets enter a new - and higher - trading range? Several factors are on the verge of being resolved, and they will determine if the next leg is up or down. A quick look at both sides of these issues:

Positive elements for a rally are as follows

• War in Iraq was resolved quickly;
• Earnings are better than expected (so far);
• Money flows into equity mutual funds have flipped from negative to positive over the past month; 4th consecutive week of inflows (versus outflows) to stocks;
• Money Market funds report outflows of $47.1 billion;
• Heavy short interest -- especially in NDX names -- is potential near term catalyst;
• NDX and S&P at or above their 200 day moving averages.

Risk factors which could derail any moves up:

• Continued geopolitical fallout from the mid-East;
• Relatively high valuations (30 times P/E for S&P500);
• Expectations have been lowered dramatically - so beating numbers isn't all that significant;
• Consumers potentially tapped out as mortgage refinancing boom tapers off;
• Corporate spending still not visible on the horizon;
• Increasing Federal deficits threaten low rates;
• Taxable Bond funds inflows were ten times higher than equity flows;
• Bull/Bear ratio shows too many bullish people - no wall of worry for the market to climb;
• The markets are approaching the top end of the trading range, with significant resistance ahead at S&P 900-905 and NDX 1085-1100.

In this fairly balanced tug of war, 2 factors will likely tip the scales. The first is psychology, especially amongst the fund managers. Their palpable fear of missing rallies has them deploying capital first, and asking questions later. This lends a slightly bullish tint to the overall landscape.

The 2nd is the internals; They have been constructive over the past month. Up/down volume and the advance/decline lines are no longer distributive. This also has a bullish hue.

The path of least resistance - at least for the next few weeks - appears to be upwards.

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Quote: “Men judge us by the success of our efforts. God looks at the efforts themselves.” - Charlotte Brontë, 1816 - 1855

The looting of the Baghdad Museum

Saturday, April 19, 2003 | 08:48 AM

in Current Affairs | Media | War/Defense

We had family visiting us in NYC from Virginia and Chicago this weekend. One of the places we took everyone was to the Metropolitan Museum of Art.

Schools were closed, so the Museum was absolutely jammed with visitors. As we were walking around, I thought about the losses suffered by the Baghdad museum, which has been described as having the greatest collection of Middle Eastern artifacts in the Middle East. The "looting" was detailed in a Salon article.

I imagined how much poorer NY would be if the Met were looted. The cultural loss, the irreplaceable artifacts, a jewel of the city destroyed. I tried to visualize a mob of crazed NYers looting the Met.

It was at that moment that I realized the looting story -- at least the version reported on TV and in the mainstream press -- was sheer and utter nonsense. Though I don't doubt the museum suffered in the post-regime chaos, the "official" story does not ring true to me.

Here's why:

After the viewing the Manet/Velasquez show, we strolled through Islamic Art, then the "Ancient Near Eastern Art", and then onto the Egyptian collection. (All viewable here: Ancient Near Eastern Art, Egyptian Art, Islamic Art)

Pictures do not do the collection any justice. You must be physically present to feel the scale.

Although there are plenty of smaller items -- jewelry, portraits, earthenware -- throughout the galleries, the bulk of what is on display is, well, bulky. As you tour the galleries, you are stricken by the enormity of the work. These pieces are simply massive, and the materials -- stone, granite, marble -- exudes heft. Statues, architectural details, sarcophagi, headresses, pillars, vases. Most of these things are simply enormous, and must weigh in the tens of thousands of pounds.

Even the medium statues appear to weigh many tons. That these items were created thousands of years prior to mechanical lifts, cranes or power tools only adds to the awe and wonder they inspire. But even smaller items must weigh a few 1000 pounds apiece. (4:53pm: I've read that the cuneiform tablets missing from the museum were palm sized and easily portable).

It also makes the visual of a frenzied mob's spontaneous "snatch and grab" utterly laughable. Anything of size which was removed was likely the result of careful planning, coordinated teamwork, forklifts, trucks and lots of cautious packing. Oh, and a lot of time, too.

Of course, carrying out small items could be fairly easy. But so much of what's in this collection would require a well organized team of professionals several days to make off with a small percentage of the medium size items. The bigger pieces would have taken more time, manpower, and machinary.

I don't know the size Baghdad museum, only that its collection held 170,000 artifacts, which sounds pretty large. If its even 1/4 of the physical size of the Met -- and Saddam never did anything small -- it would be exhausting just getting from the galleries to the front doors carrying a small item or two.

It's one thing to spontaneously carry away chairs from the ministry of information; But to loot a world class collection like the Baghdad Museum over 2 days simply defies the imagination.

Do the Math:
48 hours contains 172800 seconds. There were ostensibly 170,000 items in the collection. That breaks down to about one item leaving the baghdad museum EVERY SECOND during the entire period in question.One per second. Regardless of the size of each piece, that seems extraordinairy; Its an astonishing feat for that amount of material to be moved in just 48 hours.

I find the official tale of what happened wanting; We may never know what actually occurred for many years. One thing is for certain: When large and delicate items show up in the public art market private decades from now, it will be apparent whether or not these artifacts were carefully crated before they were moved.Only then will the truth be fully known.

April 19, 2003, 8:48am EST

Farewell to Arms II

Thursday, April 17, 2003 | 10:44 AM

in Finance | War/Defense

After a strong pre-war rally, the market is now marking time. The short term oscillators are somewhat overbought, while longer term indicators – the Arms index in particular – still suggests an oversold condition.

Additionally, the markets have butted right up against key resistance (see chart at right), and after their recent romp upwards, are a bit too tired to mount a serious offensive on those levels. After recent gains, continued market consolidation right here – at the 8250–8550 levels –should be viewed positively. Note that each attempt at that resistance weakens it each time.

This suggests that pullbacks should be bought, unless and until the recent up-trend is broken.

When the news is mixed, observing what investors are focusing on can provide insight into their collective psyche. Ultimately, this is more constructive than their hanging on every Centcom briefing, tactical victory or setback of the war. Since Saddam’s statue came down, investors have focused on earnings (fair to good) and the economy (poor).

This helps to explain the recent action; It’s probably why 3M and Coca Cola stunk the joint up yesterday. They set the tone for the overall markets, despite lots of other good news. One might have expected the positive surprises from Microsoft, Intel, TI, EMC, J.P. Morgan, and Ford to have turned the broader indexes green yesterday; Instead, the focus was on negatives.

So while it’s a welcome change that investors are paying attention to market-related developments, understanding their nervousness is crucial. The focus shifts to GDP, growth, unemployment, federal deficits, and IT spending; Earnings expectations have been set low enough that anything short of horrific is being viewed positively.

With good news being discounted, and nervous share holders quick to lock in profits, it’s advantageous to watch the market’s internals – and they are not so bad.

After the past few years, one can hardly blame emotional investors for selling gains somewhat prematurely. It’s worthwhile to observe that many investors continue to be locked into an overtly emotional money management scheme. Day-trading may have faded dramatically, but undisciplined knee jerk responses to the daily headlines continues unabated.

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It’s the Earnings, Stupid!

Monday, April 14, 2003 | 10:58 AM

in Finance

With the war starting to recede into the rear view mirror, the market must now digest actual quarterly numbers as reported by public companies. This holiday shortened week will tell whether this is a “Good Thing” or not.

Before the open today, half decent news came out of the big financials: Bank of America and Citigroup each beat earnings expectations, though each did so while coming up short on revenues. Fannie Mae also beat.

These earnings - and upcoming releases from J.P. Morgan and Merrill Lynch on Wednesday - are significant to the Bull camp. Markets need leadership, and if there is to be any type of sustainable post-war rally, it will need direction from the financials. That makes the performance of the banking and finance index (BKX) an important tell going forward.

Technology also tends to lead the market when it’s in rally mode; Given present valuations, that may be asking a bit much. IBM and Novellus report today, Microsoft, Intel, Motorola and TI tomorrow, and on Wednesday, we hear from AMD, Apple, EMC and Mercury Interactive. The market is expecting little, but hoping for a lot from the tech sector.

We are preparing to Clone the Nose!

While there is nothing funny about the horrors of War, we cannot help but be amused by the antics of Mohammed Saeed al-Sahhaf, the Iraqi Minister of Information. The star of his own “Theatre of the Absurd” al-Sahhaf made outrageous claims of Iraqi victories in battles against the U.S. Indeed, several commentators marked the end of the War not by the fall of Saddam’s statue, but by the failure of al-Sahhaf to come to work last Thursday. He has neither been seen nor heard from since then.

Where the Iraqi Minister is - and what his post war plans might be - was fodder for Dave Callaway. He suggested that al-Sahhaf was probably “running around the backstreets of Baghdad right now with Saddam's nose in a box” hoping to rebuild his blown-up leader like they tried to do in Woody Allen's "Sleeper."

Callaway’s most interesting suggestion was how to put the Minister back to work after the war: Instead of working for Saddam, al-Sahhaf should find gainful employment in the U.S. as a corporate flack, spinning the debacle du jour to restore confidence in scandal-plagued Corporate America.

We think he may be on to something.

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Quotes: “The fundamentals are horrible - but the news is always worst at the bottom. The internal Minxy mechanism is showing constructive signs - but we remain firmly entrenched in a negative trend. Performance anxiety creates self-fulfilling demand - but optimism is historically bearish. And the allocation rotation into equities will drive prices higher - until it doesn't.” -Todd Harrison, on why these Markets are so challenging

Farewell to Arms

Thursday, April 10, 2003 | 10:09 AM

in Finance | War/Defense

Farewell to Arms?: Scenes of jubilation in downtown Baghdad as a statue of Saddam tumbled down. Traders were transfixed, watching a seminal moment in history. As Freedom and Capitalism take root in Iraq, the question remains: How long before the head of that Saddam statue is auctioned off on eBay?

The Dow briefly rallied on the tumbling statue footage before tumbling 180 points itself, to close down 100. Why? As 24/7 war coverage recedes, the market starts focusing on other things: The Economy, corporate earnings, hiring and spending. You can forgive investors for wishing the war lasted another 2 weeks - at least long enough to distract from what may be a disappointing earnings season.

The post-war Bullish case will now be put to the test. Mop up operations will continue, with pockets of resistance and sporadic fighting expected. Iraq continues to be dangerous, and we expect more casualties. But with the “heavy lifting” now over, it behooves us to look at the Bull’s contentions:

• The War was distracting CEOs from hiring and spending;
• Consumer confidence was negatively impacted;
• Victory increases the chance a tax cut passes;
• War limited visibility, keeping earnings expectations low;
• The markets initial rally was “looking through” the war -- and seeing an economic recovery on the other side.

This thesis will be verified (or not) over the coming months: Regular increases in hiring and IT spending, consumer confidence spikes, a tax cut goes through, and the GDP ticks up -- these will vindicate the Bulls. Not surprisingly, the Bears make a different case:

• The relief rally was an oversold bounce;
• Earnings remain weak;
• Valuations are still dear;
• More conservative accounting restrains earnings growth;
• Real estate prices remain vulnerable to rate increases;
• Double dip recession.

Either of these cases may be preferable to the frustrating middle ground: markets remain range bound, sporadically rallying and retreating. The bear market ends, but a new bull market remains elusive, perhaps years away.

If the market maintains a new trading range (last Monday’s lows as the bottom), it will be just that: A challenging no- man’s-zone as the base building process continues.

In the land where the dominant direction is sideways, capital preservation and yield are kings.

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Quote: “If anyone disagrees with anything I say, I am quite prepared to not only retract it, but also to deny under oath I ever said it.” -Tom Lehrer(no relation to the Iraqi Info Minister)

The Fall of Baghdad

Monday, April 07, 2003 | 10:22 AM

in Finance | War/Defense

“Upside” risk has been the Trader’s cry the past 4 Fridays, as shorts contemplate the risk of positive news over the weekend. The wisdom of covering large positions was finally proven prescient since the bell rang Friday:

• Southern Iraq is firmly under US/UK control;
• US tanks take Presidential palaces in Baghdad;
• Chemical Ali killed in air assault;
• The Republican Guard “effectively” destroyed;
• Baghdad slipping with a minimum of “Urban Combat;”

While the war is far from over, the weekend’s progress is reflected in the futures (+2%) this morning.

Instead of focusing on “obvious” news, I wanted to bring 3 under reported items your attention. Yes, the gap up this morning is headline driven, but other positive stories m ay also be contributing to the positive action. Its important to contemplate these items before the contrarian wannabes dismiss today’s rally as an overreaction to good war news:

1) China slaps North Korea: The Washington Post reported that the Chinese government has warned North Korea to “stop provoking the United States while they are at War.” To emphasize this, China closed an oil pipeline to North Korea and stopped food shipments. North Korea got the message (annoying Japan instead). China realized the US had no tolerance for Jong Il during war, and is signaling their plan to be key in resolving Korean issues once the world’s focus shifts from the Mid-East to Asia;

2) Cheering Throngs? Also getting overlooked is some incredible cooperation and intel from Iraqis: Consider 3 operations: The intial “beheading” strike at Saddam, the rescue of PFC Jessica Lynch, and the air attack on “Chemical” Ali. Its doubtful any of these could have been successful executed without collaboration from individual Iraqis. Though expectations of being greeted ala Paris ‘45 were too high - the population has been cowed by decades of intimidation and torment; Somebody on the ground is cooperating, and that assistance is having a major impact on the prosecution of the War;

3) SARS Panic may have peaked: Note that this epidemic has fatality rate of 3-4% -- hardly the cause for mass hysteria or obsession we’ve seen in some quarters. Expect this to recede as a major threat over the next few months;

Traders should be cautious not to presume, as some have irresponsibly declared, that the War is over. Its not, and their will continue to be American casualties as the troops shift towards more of a mopping up operation. Note that cornered animals can be the most dangerous, and the ever-present threat of bio/chemical attacks remains.

None of this means valuations are cheap, but it does support a 10-15% rally over the next 90 days. Last Monday’s lows remain your new stop losses.

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Quote: The only reason for time is so that everything doesn't happen at once.
- Albert Einstein, 1879 - 1955

Where’s Waldo?

Thursday, April 03, 2003 | 10:29 AM

in Finance | War/Defense

Since the war began via an attempt to behead the regime with a precision-guided strike at the Iraqi leadership, the operative question for everyone watching is simply: Where's Saddam?

The U.S. would like to know; Did we get lucky with our 1st attempt? If not, we may want to take another stab at it.

His ministers would like to know; The brave faces they put on while reading statements allegedly written by Saddam reveal that they have no clue where he is.

The Iraqi Saddam Fedayeen want to know; Without Saddam around, their world collapses. If Saddam is dead or gone, what is the point of their suicidal battle? With Saddam gone, the Fedayeen would need to get out of Dodge.

The Iraqi people would like to know; They fear supporting the U.S. troops if there is the slightest chance that the horror of Saddam returns; They relied upon the U.S. last time when rising up against Saddam - and got slaughtered.

The so called Arab Street wants to know; Anger at the “infidel invaders” has elicited a swell of Arab Pride, though quite frankly, its hard to imagine what there is to be prideful about; Are they please by the benevolent rule of Saddam? Perhaps it’s the way his troops have defended the motherland by hiding in Mosques and children’s playgrounds and hospitals, whilst wearing women’s clothing and falsely waving white flags. Perhaps their pride stems from the region’s contributions to progress over the past 500 years.

Lastly, Mr. Market would like to know. He’s been careening between elation and despair, depending upon the latest headlines. Two weeks ago, he was ecstatic in his assumption that the war would be a cakewalk. A few days ago, he was in the throes of despair, having convinced himself that the war would slog on for months; As of 5 minutes ago, the latest intel suggests the war will last a matter of weeks - our boy has put on his party hat.

Despite - or perhaps because of - the Saddam question, it pays to look into the Mr. Market’s internals: Most noteworthy is that Monday’s lows represented a ~50% retracement of the initial war rally; A market up 13% in eight days is way ahead of itself, and a healthy pullback sets up a more sustainable ascent. A 50% retracement holding shows that buyers have conviction; Had they not shown themselves, a retest of the lows would have been likely. Investors buying after prices were pushed that far back suggests that the market has a established a short term bottom. If buyer’s fail to materialize on a 50% pullback, than a retest of the lows becomes likely.

The lows from Monday are your new stop losses.

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Quotes: “"Superiority of numbers is the most common element in victory. . . . Superiority . . . can obviously reach the point where it is overwhelming. . . . It thus follows that as many troops as possible should be brought into the engagement at the decisive point."
-Prussian military theorist Carl von Clausewitz