Note: Professor Fleckenstein provides his commentary for educational purposes - his insights are not intended as investment advice. You can find his daily comments at www.fleckensteincapital.com
Four Bumps and a Jump . . . Not Today
Preopening, the most important factors impacting today's activity were Cisco's (CSCO:NASD) slightly disappointing earnings report (more about that below) and the slightly better-than-expected trade deficit. The latter weighed in at $51 billion for the month, rather than $53 billion, but you can be pretty sure it will rise next month. The price of oil that goes into the calculation was a bit over $37 a barrel, and according to the data, oil imports were down 10%, apparently affected by the hurricane. Next month will also reflect the impact of all the imports in advance of Christmas. In any case, I see no real difference whether this trade deficit is $49 million or $56 million, etc. The point is, it's completely out of control.
A Dollop of Gain, a Wallop of Pain
Back to stock land, the early going was again the scene of helter-skelter activity, as Cisco was down 4%, but look-a-like Juniper was actually up. (With about an hour to go, when I had to leave, Cisco was down about 6%, and Juniper (JNPR:NASD) was still clinging to its gains.) The Sox was under pressure, down about 2%, but Internuts were green, and ditto that speculative contingent: Travelzoo (TZOO:NASD) / Research in Motion (RIMM:NASD) / Taser (TASR:NASD).
As for the crazed action in single-digit-midget land, Analytical Surveys (ANLT:NASD) was up 100% in the early going. That stock is now trading at almost $9, having sold for a little over a buck two days ago. So, the early morning was in essence the same sea of chaos that has become the norm, and I'll have much more to say about that below.
The day's action continued schizophrenically in a kind of choppy fashion, until the Fed announced its rate hike. That precipitated a small pop in the market, though I don't know exactly how it closed, in view of my early departure from the office. My guess is that tomorrow's trading in all markets will be a little more informative than whatever took place in the last hour today.
Action a la Jambalaya
Away from stocks, there was a lot of motion in the currencies/metals around the trade-deficit number. In fact, there was so much motion in the early going, even before the Fed did its deed, that it's not worth describing all the different wiggles. By day's end, the metals closed a bit lower, though trading there stopped before the Fed announcement. Fixed income closed fractionally lower and oil closed up about 3%. The currencies were mixed with small changes, both before and after the FOMC announcement. In other words, the early action on the back of the announcement didn't do much of anything.
As I just said about equities, I think that tomorrow's action in the metals and currencies will be a lot more informative, not least of which due to the considerable chatter out of ECB types today. According to a Bloomberg story, Market News International quoted ECB "sources" as saying: "The ECB is comfortable with the euro at $1.30. . . . ECB can tolerate euro at $1.35, as offsets oil. . . . ECB sees euro near $1.40 as problematic, unwelcome."
In checking with a source of mine who traffics in central-bank minutiae, he said that this story was "legit," and the result of Trichet popping off the other day about the strong euro being brutal. In other words, the ECB is airing their dirty laundry in public. So, we'll just have to follow that bouncing ball.
Walks Like a Duck, Slides Like a Greenback
For folks who haven't already divined it, the administration has indicated that it's definitely rooting for a weaker currency, with the apparent media mouthpiece being Greg Ip of The Wall Street Journal. Case in point: today's page-one story, "Bush Policy: Talk a Strong Dollar, But Let It Slide." They will ultimately get their wish -- and then rue the day they wished for it.
The Overcapacity Kid
Turning to Cisco, there really isn't much to say. That stock had been bid up in expectations that John Chambers would get the fans excited. In fact, Cisco barely made the numbers. Their deferred-revenue line was tapped for about $300 million, meaning that the numbers were a little worse than they read. And, Cisco's inventories did not decline at all, which is another data point corroborating the problem in chip land. Inventories have failed to decline for about six months, as I have been pointing out.
Of course, I can tell you why that is, because essentially, nobody's cutting production. The semiconductor companies attempt to keep up a brave face as they lower their guidance but try to talk bullishly. At the end of the day, however, there's too much capacity. The companies will need to cut it, and that's going to wreak havoc with margins. The only people who'd own chip stocks are people playing with other people's money, or people who think the charts are all that matters.
On Safari to Speculation's Source
Now, following up on that thought, I'd like to share an insight that finally hit me between the eyes yesterday. If everyone else has already figured this out, I'm sorry that I am the last one to know. In any case, I think that what I'm about to discuss explains why the market has behaved in such an increasingly speculative, chaotic manner for about the last 10 years, versus how it behaved in the 1980s (or even the early 1990s, for that matter).
When I started out in the investment business in 1982, most money was run by banks and investment-counseling firms. I was part of the latter community. Back then, I believe that the investment world tried to act pretty responsibly. They really did worry about risk, viewing the money entrusted to them as though it were their own.
Opting Out of OPM-Mania
One of the reasons I left the investment-counseling business in 1995 was that I could see the crazies were going to get the upper hand. As the public began to take charge of their money and gave it to mutual funds, I realized that it was going to create an environment where my concept of the best way to run money would not be particularly successful. In other words, there was no way I was going to be at the top of the performance sweepstakes, which is what folks demand.
I believe that the behavior of the public helped drive the mutual-fund industry to the sort of gunslinger mentality that prevailed in the late 1990s and early 2000, where all the money flowed to the zaniest money managers who put up the biggest numbers. That mentality is similar in the hedge-fund community, where more money has moved over the last few years, though it could be argued that some of these people have actually put a portion of their own money at risk, so they behave in a saner fashion.
Career Risk vs. Portfolio Risk
The bottom line is that we have bred a much more speculative, trading-oriented community. Instead of worrying about losing money, the overwhelming majority worries that they won't perform well enough on the upside. The fear of getting fired for not having made enough is the driving factor. In a recent article, Jeremy Grantham described this brilliantly:
"In markets where investors hand over their money to professionals, the major inefficiency becomes career risk. Everyone's ultimate job description becomes 'keep your job.' Career risk-reduction takes precedence over maximizing the client's return. Efficient career-risk management means never being wrong on your own, so herding, perhaps for different reasons, also characterizes professional investing. Herding produces momentum in prices, pushing them further away from fair value as people buy because others are buying." That, ladies and gentlemen, is a perfect description of what the professional money-management business has become.
Jeremy goes on to make a couple of insightful points: "Refusing, on value principle, to buy in a bubble will, in contrast, look dangerously eccentric. And when your timing is wrong, which is inevitable sooner or later, you will, in Keynes' words, 'not receive much mercy.'" He sums up what that means to the folks who try not to go with the herd and do the right thing: "Today the challenge is not getting the big bets right. It's arriving back at trend with the same clients you left with. . . ."
Dislocation Before a New Dawn
I myself continue to expect the investment business to revert to the saner style that I grew up with. This is not to say that the market then didn't do weird things, confound people, or get out of whack. It did. It just wasn't anywhere nearly as maniacal as it has become. To repeat, I fully believe that we will eventually revert to a more conservative environment. But I think the only way that can happen is through some sort of a market dislocation, as I have been discussing for at least the last six months. Though it has not yet occurred, I continue to think it will at some point. I just don't see how the structure presently in place can unwind in anything but a violent manner that involves some dislocation.
I think that if one approaches their own problems or disputes with the market by first knowing the personality of the enemy, if you will, that can perhaps make it possible to be more successful. I know that in my own short-selling, when I act as though the guys I'm "fighting against" will behave in the manner I've described, I often do better. For example, when I get out of the way because we're in the no-news season and I expect "them" to take stocks up, even though it doesn't make sense that "they" should. Oftentimes that tactic works better than sticking with my shorts, as I have done recently, with the view that the dire macro problems will matter.
Of Dilettantes and Their Wants
I believe that it's the demands of individuals and committees that run employee-benefit plans -- two groups that are not really investment professionals and tend to want to buy high and sell low -- which are partially responsible for the behavior of the professional investment community. Whether it's Joe and Jane Six-Pack deciding for themselves, or the committee that runs Joe and Jane Six-Pack's money, these are not sophisticated investors.
They think they've been around the investment markets, but they've really only grown up in a bull market. These are the folks who are not particularly good at risk management, and they're the ones setting the incentives, as described by Jeremy Grantham, that have produced the market environment we are now in. Hopefully, that long-winded discussion will help folks deal with this environment.
Toppling Technical Analysis from Mt. Olympus
Lastly on that subject, I think that because of the moment-to-moment performance demands that people now perceive, and the advent of PCs, technical analysis has become the vehicle of choice for doing "analysis." The fact that everybody has all the technical bells and whistles at their fingertips I think has made people believe too strongly in the merits of technical analysis, such that the recent breakout in the S&P means to everybody that the market must trade higher at the end of the year, and none of the facts matter.
Now maybe they will get that right. But I think at some point, technical analysis will be the "big hook" in the market that will trap people. Technical analysis is a tool, like bottoms-up fundamental analysis or looking at the macro environment. It's just one tool -- not the be-all and end-all that folks seem to think. It's not surprising, given the environment that I have described, that technical analysis has been elevated to such high status. But folks who only believe in charts I believe will ultimately come to learn that there's a lot more to it than that.
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