Note: Professor Fleckenstein provides his commentary for educational purposes - his insights are not intended as investment advice. You can find his daily comments at http://www.fleckensteincapital.com
Momentum Rules . . . Until It Doesn't
Yesterday pre-opening, there were a handful of data points that have ramifications worth discussing. Wal-Mart (WMT) lost, while Target (TGT) and the U.S. economy (in the form of retail sales) won at beat-the-number. Those three data points tell a story, in my opinion.
Stagflationary Supplies, Aisle 1
First of all, it's a little hard to believe that the growth in the retail-sales estimate can be taken seriously when whatever growth occurred did not translate to profitability at a firm like Wal-Mart -- which by itself comprises over 10% of U.S. retail sales. In other words, the stagflationary environment that we're in is raising havoc in lots of places.
The fact that Target was able to do a bit better potentially illustrates the bifurcation in the U.S. economy, where people with money or a house (often the same people) are doing well, while people less well-off are really getting squeezed. A thesis could be constructed that Target has a slightly higher-end shopper, even though the profiles of both companies' customers are somewhat similar. To my mind, the troika of data points illustrates the problem faced by the economy, and the predicament the Fed is in.
That said, the currency market's reaction to yesterday's headlines demonstrates a completely different point. On the back of the retail-sales headline number, the dollar exploded higher about 0.75% against virtually every other currency (which in turn dragged the metals down), as the forex markets completely overlooked the ramifications of the Wal-Mart news. That illustrates the point that in many of these markets, when momentum gets established, momentum trumps the fundamentals, especially nearing the end of a move. (More about that below.)
The Engine of 'Anticipation'
Turning to the equity market, we opened a bit higher yesterday, then began flopping and chopping with a slightly upward tilt. The Nasdaq was doing better than the rest of the tape, led particularly by chip stocks. A knowledgeable reader passed along a report from the big dead-fish house, Goldman Sachs (GS). One of its comments kind of says it all about the infatuation with tech stocks: "Anticipation of a year-end rally should support stocks, despite fundamentals."
The report noted that IT spending continues to deteriorate, but the particular dead fish who wrote it thinks that tech stocks will go up because they have gone up in the second half of the last six or seven years. That's a variation of the thought I mentioned earlier about momentum, a.k.a., market action trumping the news. Of course, momentum as the driver of markets is more pronounced now than ever, given the fact that we have so many hedge-fund "operators."
Sidelined by the Cyclicals
In any case, the market basically flopped around not far from unchanged until about midday. It then began to fall out of bed as the complete pounding the cyclicals were taking pressured other stocks, i.e., the financials, homebuilders, and even the heretofore green tech stocks. I heard a number of stories that in credit land, all sorts of paper was spreading out once again today.
Thus, beneath the surface of a reasonably decent (though not bone-shaking) decline in the averages, this was a day where selling begat selling and gathered momentum all session. In sum, it was a very heavy day.
Away from stocks, oil was down 4%. Fixed income was slightly higher. As I noted earlier, the dollar was strong, with the euro closing down 1% as it broke some "important" levels. The precious metals were hit hard, as silver closed down 2% and gold closed down 1.5%. Once again, the metals stocks were hit even harder.
Milking Momentum for Clues
Now for a moment on momentum and market turning points. We have seen repeatedly how momentum-oriented markets go and go and go, and near the end of the moves, even when the facts begin to change, they keep going, simply because they had been in motion. I sometimes look for that sort of action to tell me that maybe we are close to a turning point.
Thus far this year, the euro has been rather heavy, which even though I am very negative on the dollar long-term, I have been expecting, as I have been out of my FX positions since January.
On the other hand, the metals have been heavy too, which has caught me by surprise, since I have been expecting that the metals would be the beneficiaries of the fact that there is no good currency of last resort. Thus far, that idea/theory has not taken hold in the foreign-exchange market.
Dissecting Silver / Gold Doldrums
In hindsight, what's occurred has been the following: The metals have been treated solely as a surrogate for the euro. The metals stocks figured out that there were inflationary cost pressures at mining companies, and that metals prices would not divorce themselves from other currencies. Therefore, it was still business as usual, which obviously was not my conclusion. However, not having perfect hindsight a few months ago, there was no way that I personally could have walked around without my metals exposure, since I don't have any FX exposure.
Currently, we're at the point where the metals are going down simply because they've been going down, and the metal stocks are going down about twice as fast as the metals themselves, simply because they've acted even worse than the metals.
I think we are approaching a very interesting opportunity, in both the metals and the metals shares. I am especially keen on silver, as the supply-and-demand situation continues to tighten. I am going to try to capitalize on this decline by adding further to my positions. In any case, the momentum nature of these markets is something that we all need to keep in mind as we construct our positions. You can take advantage of it if you can spot it, but not if you've been trapped by having too big a position in the first place.
A Newton Law in Nasdaq Land
Similarly, momentum tends to rule the stock market, and we often see stocks doing their best, vis-a-vis the news, shortly before they're about to flip over and go down. Oftentimes on the lows, we see stocks doing their worst, i.e., going down on news when maybe they shouldn't, shortly before they turn.
However, in the last couple of weeks of earnings season, the market absorbed a fair bit of bad news and did not really go down well at all. Since then, it's not been able to mount much of a rally, after having bucked bad news pretty well, though serious cracks in the edifice did begin to appear today.
Pondering a Re-Entry Point
The reason the near term matters to me so much lately, as I said before, is because I have whittled down my short position rather significantly, only keeping a handful of names. I am looking for an opportunity to aggressively re-establish those positions. If the market were to rally for a couple of weeks, I think it would set up a tremendous opportunity. But if the market can't, given that we're in the "no-news" period, that would speak volumes -- indicating that the undertow of credit problems and liquidity being withdrawn are getting the upper hand, perhaps negating any chance of a no-new-period rally.
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